TMI Blog2010 (1) TMI 47X X X X Extracts X X X X X X X X Extracts X X X X ..... glect on the part of VAR. As regards the perusal of the financial statements, the applicant clarifies that it is meant to ensure that the VAR is not selling competing products in violation of the restrictions imposed. The restraints placed on VAR not to market or license competing products subject to certain exceptions is again not a factor that points to the existence of principal and agent relationship. – applicant has no PE in India - It is ruled that the payment received by the applicant from VARs (“third party re-sellers”) on account of supplies of software products to the end-customers (from whom the licence fee is collected and appropriated by VAR) does not result in income in the nature of royalty to the applicant and moreover payments received by the applicant cannot be taxed as business profits in India in the absence of permanent establishment as envisaged by Article 7 of the India-Japan Tax Treaty. - 821/2009 - - - Dated:- 29-1-2010 - Mr. Justice P.V. Reddi (Chairman) MR. J. Khosla (Member) Name address of the applicants: M/s. Dassault Systems K.K., Pier City Shibaura Bldg., 9Fm 3-18-1, Kaigan, Minato-ku, Tokyo 108-0022, Japan Commissioner concerne ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d risk in relation to the end customer lies solely with the VAR. - Simultaneously, VAR also obtains a signed and sealed End User Order Form from the customer, which describes the software ordered and whereby end customer accepts 2 the licensing terms of the EULA. This EUOF does not bear the end customer price. The EULA is standard and does not bear any price. - The VAR then places a PO with the applicant with the price obtained from either the SBO request or based on list price minus VAR discount. The End customer has no knowledge of this PO, since this is an arrangement between the applicant and VAR. For an order of a new software product, the Brand Order Form must be accompanied with a request for media, a request for license key and the signed EUOF; - The applicant is not duty bound to accept the PO; - If and when the PO is accepted, the applicant provides a license key via e-mail and download link directly to end customer. Simultaneously it invoices the VAR. 2.1. As to the manner of supply of product to the customer, the applicant states: The product will be hosted on a server located outside India. The end-user in India will electronically download the Product by ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rovisions of DTAA will prevail over the provisions of the I.T.Act on the same subject-matter in a case of conflict if they are more beneficial to the tax-payer (vide Union of India vs. Azadi Bachao Andolan (263 ITR 706 at pages 723 724). The Circular of CBDT dt.12th April 1982 approvingly cited by Calcutta High Court in Davy Ashmore's case (190 ITR 626) further clarifies that "where a specific provision is made in the DTAA, that provision will prevail over the general provisions contained in the IT Act". At this juncture, we may mention that there is no material difference and no conflict between the provisions of the Act and DTAA and therefore the conclusion is reached by referring to both. 6. Article 12 of the DTAA lays down the rules for taxation of "royalties". The relevant part of Art. 12 is extracted below : "Article 12. 1. Royalties and fees for technical services arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other Contracting State. 2. However, such royalties and fees for technical services may also be taxed in the Contracting State in which they arise and according to the laws of that Contracting State, bu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rom the classic treatise of Copinger and Skone James on Copyright (1999 Edn): "Copyright gives the owner of the copyright in a work of any description the exclusive right to authorize or prohibit the exploitation of the copyright work by third parties. This includes the right to copy the work itself and also to use the work in other ways protected under the law".(p.26) Copyright is often described as a negative right. This idea is conveyed by Copinger in the following words: "Copyright, however, does not essentially mean a right to do something, but rather a right to restrict others from doing certain acts, and, when copyright is referred to as "an exclusive right," the emphasis is on the word 'exclusive'. Thus, the 1988 Act, whilst not defining "copyright" otherwise than as a property right, which is transmissible as personal or moveable property, provides that the owner of the copyright in a work has the exclusive right to do the acts restricted by the copyright in a work of that description specified in the 1988 Act.(Copyright, Designs and Patents Act, 1988 of UK)" (p.27) The following passage also deserves notice: "It is important to recognize that ownership of copyri ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... pointed out earlier, an exclusive licensee is recognized as an owner of the copyright under Section 54 of the Indian Copyright Act entitling him to all the remedies by way of injunction, damages etc. for the infringement of a right, subject to the requirement of Section 61 that in a suit instituted by an exclusive licensee, the owner of the copyright shall ordinarily be made a defendant. 10. In order to appreciate the legal issue, it would be appropriate to refer to the provisions of The Copyright Act, 1957 (hereinafter referred to as 'CR Act'). This Act was brought into being by repealing the earlier Act of 1914 with a view to amend and consolidate the law relating to copyright. It broadly follows the model of the British Copyright Act of 1956 which has since been replaced by the Copyright, Designs and Patents Act of 1988. Section 16 of the CR Act lays down that no person shall be entitled to copyright or any similar right in any work, otherwise than under and in accordance with the provisions of this Act or of any other law for the time being in force. The works in which copyright subsists throughout India are specified in section 13 as (a) original literary, dramatic, musical ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... x xx xx xx xx xx" 10.2. Section 18 of CR Act provides for assignment of copyright by the owner either wholly or partially and either generally or subject to limitations. Sub-section (2) of section 18 provides that in a case where the assignee of the copyright becomes entitled to any right comprised in the copyright, the assignee as respects the rights so assigned and the assignor as respects the rights not assigned, shall be treated for the purpose of this Act as the 'owner' of copyright. The mode of assignment is provided for in section 19. Section 30 provides for the owner of the copyright in any existing work or the prospective owner of the copyright in any future work may grant any interest in the right by licence in writing signed by him or by his duly authorized agent. An exclusive licence is defined to mean "a licence……. (vide S.2(j)) Section 54 which occurs in Chapter XII "Civil remedies" specifically states that the expression "owner of copyright" shall include an 'exclusive licensee'. The owner of the CR Act can maintain an action by way of injunction, damages etc. for the infringement of copyright in any work (vide Section 55). Section 61 enjoins that in any civil suit ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... h it was supplied; (ab) the doing of any act necessary to obtain information essential for operating interoperability of an independently created computer programme with other programmes by a lawful possessor of a computer programme provided that such information is not otherwise readily available; (ac) the observation, study or test of functioning of the computer programme in order to determine the ideas and principles which underline any elements of the programme while performing such acts necessary for the functions for which the computer programme was supplied; (ad) the making of copies or adaptation of the computer programme from a personally legally obtained copy for non-commercial personal use." 10.5. Adaptation is defined to mean "in relation to any work, any use of such work involving its rearrangement or alteration". 11. Computer software is embraced within the definition of literary work in the Indian Copyright Act. Even otherwise, the computer programme embedded in the software is a scientific work. In the I.T.Act, Computer software is defined in Explanation 3 to Section 9(1)(vi) to mean any computer programme recorded on any disk, tape, perforated media or ot ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... how the undefined terms shall be understood. In substance, it says that an undefined term shall have the meaning which it has under the taxation law of the State concerned. When the term is not defined in the taxation law (Income-tax Act), the definition in the law governing the subject-matter ought to be adopted, more so when there is no basic difference between the statutory definition and the ordinary legal concept. Section 16 of the Copyright Act lays down that no person shall be entitled to copyright or any similar right in any work otherwise than under and in accordance with the provisions of this Act or any other law in force." There is no good reason to think that under the I.T. Act, the concept of copyright has to be understood differently from that evolved under the law of the land. The reference of the Revenue's representative to the provisions in Section 115A(1A) and the 3rd Expln to cl.(vi) of sub-section (1) of Section 9 is in a different context and cannot control the meaning to be given to 'copyright'. From the said provisions, it cannot be concluded that the supply of computer software necessarily carries with it the copyright owned by the producer of software. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he computer software and a separate sub-section is enacted for 'computer programme'. The right of sale is also recognized as part of the copyright in relation to computer programme and the VAR, according to the applicant is granted such a right under the license. If so, Section 14(b) is attracted. The Income-tax Act maintains a distinction between 'royalty' arising in respect of "copyright in a book' and "computer software" as seen from Section 115A(1A) as well as the 3rd Expln to cl.(vi) of sub-section (1) of Section 9. The term 'copyrighted article' may be aptly used for a book or music CD, but it is a misnomer in the case of a computer programme (software) where one or more rights in copyright have to be necessarily transferred to make it workable. The payment is clearly for obtaining a right to copy the program on to the hard disc and to use it and therefore falls within the scope of Section 14(a)(i) of Copyright Act. The use of any right in Intellectual Property for captive use is nonetheless a business/commercial use. It is clear from EULA that the product is licensed and not sold and the consideration received is license fee. The claim of the applicant that as per the terms ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... it has no right to develop any product or derivative work from products and it has no right to engage in reverse engineering of any products for which demonstration license has been granted (cl. 3.4.1 3.4.2). VAR further acknowledges that the agreement does not grant VAR any right or license to the products or the proprietary rights therein or to the source code for the products.(cl.3.4.3). Clause 8.1 which bears 19 the heading "Ownership of Products" declares that the applicant and its licensor shall retain all right, title and interest in products throughout the world including patent, copyright and trade secret rights. Clause 4.6 enjoins that subject to clause 6, VAR shall be entitled to invoice and collect any license fee due pursuant to EULA to which it is a party and such license fee shall be paid directly by the end-user to VAR. Under clause 6, VAR shall have the sole right to set the license fee for products in accordance with clause 3.1.1. Clause 6.2 refers to 'distributor price'. It says: "VAR shall order licenses for products at the prices indicated in the brand price list effective as of the date the Company accepts the Order minus the discount rate set forth in th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ser. VAR joins the Agreement in every case in which the order is placed by end-user pursuant to a Quote issued by VAR. Clause 2.1 declares that the Company grants to the licensee (end-user) subject to the terms and conditions of the Agreement, a non-exclusive, non-transferable license to use the licensed programme on the computer equipment of the licensee. 'Licensed Program' means "(i) any data processing program for which a license is ordered by and provided to licensee pursuant to a Quote (commercial proposal), consisting of a series of instructions or databases in machine readable form (ii) associated documentation (iii) maintenance delivery (correction of errors for a given Release) (Release means a periodic update of the same version of a licensed program) and (iv) Releases". The licensee has no right to sub-license and moreover the licensed programmes can only be operated by licensee for internal use. It is specifically stated that license keys or license tokens do not themselves grant the legal right to use the licensed program. Clause 2.2 lays down the 'restrictions'. The licensee is not authorized to use the licensed programme to develop software applications for use by or ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ose software. It is not customized software. It will not be available off the shelf nor is it produced pursuant to an order placed by the end-user according to the specifications given by him. Broadly, the software products supplied by the applicant go by the description of Product Lifecycle Management (PLM) Software Solutions. PLM is "the process of managing the entire lifecycle of the product from its conception, through design and manufacture, to service and disposal". We get the description of the PLM solutions which the applicant deals with from the website, an extract from which has been placed before us by the Departmental Representative. It says that "CATIA provides solution for product design and innovation". In the brand order form pertaining to one of the VARs (TATA Technologies), the product description is given as CATIA Team PLM, CATIA - Mechanical Product Creation and CATIA - Mechanical Shape Design. Some other programs specified in 'General Brand Appendix are : Enovia VPLM, Simulia V5, KEM, 3 D Live etc. In the web site, it is stated that Enovia is for "collaborative lifecycle management, Simulia for virtual testing, 3d VIA is for online 3D lifelike experience". The ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e rights are parted with in favour of another so that the other person can enjoy that right in the same manner in which the owner can, it can then be said that those specific rights concerning the use of copyright have been conferred on him. In the instant case, the end-user is not given the authority to do any of the acts contemplated in sub-clauses (i) to (vii) of clause (a) of Section 14, not to speak of the exclusive right to do the said acts. In fact, the restrictions placed on the end-user and the VAR which have been referred to earlier coupled with a declaration that the intellectual property rights in the licensed programmes will remain exclusively with the applicant (or its licensors) and the non-exclusive and non-transferable character of licence are all meant to ensure that none of the rights vesting in the applicant as copyright-holder can be claimed or enjoyed by the licensee and that they will remain intact and are preserved. The entire tenor of the Agreement and the various stipulations contained therein make it clear that no rights in derogation of the applicant's exclusive rights in relation to the copyright have been conferred on the licensee i.e., the end-user or ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... erment of the right of use of copyright implies that the transferee/licencee should acquire rights - either in entirety or partially co-extensive with the owner/transferor who divests himself of the rights he possesses pro tanto. That is what, in our view, follows from the language employed in the definition of 'royalty' read with the provisions of Copyright Act, viz., Section 14 and other complementary provisions. 17.2. We may refer to one more aspect here. In the definition of royalty under the Act, the phrase "including the granting of a licence" is found. That does not mean that even a non-exclusive licence permitting user for in-house purpose would be covered by that expression. Any and every licence is not what is contemplated. It should take colour from the preceding expression "transfer of rights in respect of copyright". Apparently, grant of 'licence' has been referred to in the definition to dispel the possible controversy a licence - whatever be its nature, can be characterized as transfer. 17.3. We may in this context usefully refer to the well-reasoned opinion expressed by OECD in its Commentary [2008 (condensed version)] on Article 12. "Transfers of rights in re ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... amme. Regardless of whether this right (of copying the programme on to the user's computer hard drive) is granted under law or under a license agreement with the copyright holder, copying the programme onto the computer's hard drive or random access memory or making an archival copy is an essential step in utilizing the programme. Therefore, rights in relation to these acts of copying, where they do no more than enable the effective operation of the programme by the user, should be disregarded in analyzing the character of the transaction for tax purposes. Payments in these types of transactions would be dealt with as commercial income in accordance with Article 7. The method of transferring the computer programme to the transferee is not 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." 17.4. The analysis and reasoning appeals to us and it appears to project a sound approach to the issue under consideratio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rotection against loss, destruction, or damage in order to utilize the computer program 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 program 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 defined in CR Act and as understood in common law. This is because, as pointed out earlier, copyright is a negative right in the sense that it is a right prohibiting someone else to do an act, without authorization of the same, by the owner. 18.1 It seems to us that reproduction and adaptation envisaged by Section 14(a)(i) and (vi) can contextually mean only reproduction and adaptation for the purpose of commercial exploitation. Copyright being a negative right (in the sense explained in para 9 supra), it would only be appropriate and proper to test it in terms of infringement. What has been excluded under S.52(aa) is not commercial exploitation, but only utilizing the copyrighted pro ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... The VAR's role is only to forward the order to the applicant with the necessary documents. It is upto the applicant to accept it or not to accept it. Once the product is delivered to the end-user, the sale if any by VAR takes place simultaneously and that transaction is a different one. In the absence of an independent right to conclude the sale or offer for sale, sub-clause (ii) of clause (b) of Section 14 cannot be invoked to bring the case within the fold of Art.12.3 of the Treaty or Section 9(1)(vi) of the Act. It is also noteworthy that VAR is not an exclusive distributor for a territory and he does not pay any consideration to the applicant distinctly for acquiring the distribution rights. He gets the discount for each individual transaction at the agreed rate. 20. Before winding up the discussion on the copyright issue, we may usefully refer to the observations made by this Authority in FactSet Research (supra) and the decisions of the Income Tax Appellate Tribunal on the subject. 20.1. In the FactSet case, the payment made for accessing computer data base pursuant to an agreement under which the Indian customers were granted limited, non- exclusive, non-transferable ri ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sis is on the "use of copyright or the right to use it". In other words, if any of the exclusive rights which the owner of copyright (the applicant) has in the database are made over to the customer/subscriber so that he could enjoy such rights either permanently or for a fixed duration of time and make a business out of it, then, it would fall within the ambit of the phrase "use or right to use the copyright". What rights of exclusive nature attached to the ownership of copyright have been passed on to the subscriber at least partially? Is the licensee conferred with the right of reproduction and distribution of the reproduced work to its own clientele? Can it be publicly exhibited or its contents be communicated to the public? Is the applicant given the right to adapt or alter the "work" for the purpose of marketing it? The answer is obviously - no. The underlying copyright behind the database cannot be said to have been conveyed to the licensee who makes use of the copyrighted product." 20.2. A Special Bench of Income Tax Appellate Tribunal in Motorola Inc. vs. DC(IT), Delhi [(2005) 95 ITD 269], has exhaustively dealt with the question and that decision has been followed in se ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the additional right mentioned in sub-clause (ii) of clause (b) which relates to a computer programme and, therefore, what JTM or any other cellular operator has acquired under the agreement is not a copyright but is only a copyrighted article." Then, it was held: "162. A conjoint reading of the terms of the supply contract and the provisions of the Copyright Act, 1957 clearly shows that the cellular operator cannot exploit the computer software commercially which is the very essence of a copyright. In other words a holder of a copyright is permitted to exploit the copyright commercially and if he is not permitted to do so then what he has acquired cannot be considered as a copyright. In that case, it can only be said that he has acquired a copyrighted article. A small example may clarify the position. The purchaser of a book on income-tax acquires only a copyrighted article. On the other hand, a recording company which has recorded a vocalist has acquired the copyright in the music rendered and is, therefore, permitted to exploit the recording commercially. In this case the music recording company has not merely acquired a copyrighted article in the form of a recording, but h ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... pointed out that it is not necessary that the process in respect of which the consideration is paid should be a secret process. "The simple process, even if unprotected intellectual property, will fall within the ambit of royalty." It was observed that as per the Agreement, the use of process was provided by the Satellite Companies to the telecasting Companies whereby the telecasting companies were enabled to telecast their programmes by uplinking and downlinking the same with the help of that process. The assessee in that case is a non-resident company engaged in the business of providing satellite transponders to the telecasting and telecom companies in the Asian region. The payments received by the assessee were held to be royalty within the meaning of the Act as well as DTAA. We do not think that on the same analogy and reasoning, the payment received by the applicant from VAR can be treated as royalty income. We are unable to hold that the analogy of use of process in a transponder can be invoked in the present case. The nature of operations involved therein is different and not comparable to the software product with which we are concerned. We do not think that the right of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ly exercises in that Contracting State an authority to conclude contracts on behalf of the enterprise, unless his activities are limited to those mentioned in paragraph 6 which, if exercised through a fixed place of business, would not make this fixed place of business a permanent establishment under the provisions of that paragraph; (b) he has no such authority, but habitually maintains in the first-mentioned Contracting State a stock of goods or merchandise from which he regularly delivers goods or merchandise on behalf of the enterprise; or (c) he habitually secures orders in the first-mentioned Contracting State, wholly or almost wholly for the enterprise itself or for the enterprise and other enterprises controlling, controlled by, or subject to the same common control as that enterprise." Para (8) refers to independent agent. It reads: "5.8. An enterprise shall not be deemed to have a permanent establishment in a Contracting State merely because it carries on business in that Contracting State through a broker, general commission agent or any other agent of an independent status, provided that such persons are acting in the ordinary course of their business". 24.1 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ancial information and other material information which may affect directly or indirectly the performance of VAR's obligations under the agreement. 24.3. According to the Revenue's representative, these provisions in the agreement would reveal that the business of VAR is substantially controlled and directed by the applicant and VAR is economically dependent on the applicant as "almost entire business of VAR under the terms and conditions of GVA would be for the applicant and its group". The nature of records, reports and informations to be submitted by VAR would, according to the Revenue, throw light on the fact that it is the applicant which is operating vis-à-vis the end-user and the role of VAR is only that of an agent performing the functions on behalf of the applicant. These stipulations, the Revenue points out, are inconsistent with the alleged independent status of VAR. Further, it is submitted that VAR is a person who would habitually secure the orders wholly for the applicant and other companies of DS group. The fact that theoretically, VAR is free to determine the final price to be charged from the end-user does not alter the dependent status of the agent because it wo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . As noticed earlier, the acceptance of the order placed by the end-user and procured by VAR is left to the discretion of the applicant. That authority is not delegated to VAR. Moreover, VAR is free to determine its own price while entering into the deal with the end-user on the acceptance of the order by the applicant. It is not possible to accept the contention that arriving at the price is an empty formality and always follows a set pattern. The VAR does not notify or render account to the applicant for the amount collected from the end-user. The VAR cannot claim reimbursement from the applicant for the loss caused to him by reason of VAR's failure to pay the amount. It is difficult to perceive any predominant features which point to the relationship of principal and agent. As regards the obligations cast on the VAR to furnish reports and informations, it is clarified by the applicant that they are meant to help the applicant estimate the demand for the product and to ensure that adequate effort is put in by the VAR to increase sales. The customer information is necessitated in order to ensure that the product is not misused and that the service needs of the customers are attend ..... X X X X Extracts X X X X X X X X Extracts X X X X
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