TMI Blog2006 (1) TMI 167X X X X Extracts X X X X X X X X Extracts X X X X ..... ight or rental or lending right. A perusal of the agreements would indicate that none of the agreements give the assessee any reproduction right or any distribution right. It is the case of the Assessing Officer that what the assessee has got is the right under section 14(b)(ii) of the Copyright Act. The Assessing Officer has lost sight of the fact that there is a distinction between the right to sell or give on commercial rental or offer for sale or for commercial rental and exercise of that right by the various parties. What the Vendors have given to the assessee is a consequence of the exercise of the right u/s 14(b)(ii) and not a transfer of the right u/s 14(b)(ii). This distinction has been lost sight of by the Assessing Officer. It is, therefore, clear that none of the exclusive rights in a work have been transferred to the appellant. The exclusive rights in a work are the reproduction right, distribution right, rental or lending right etc. These rights have not been transferred to the appellant. What all the appellant is doing is using the software and/or acting as a distributor of the software. This brings up the question as to whether there is a distinction between the tra ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ax under section 195 in respect of payment made for purchase of software from various concerns abroad. 2. Since the appeals before learned CIT(A) were filed under section 248 of the Act, there is no finding of the Assessing Officer available on the issue. However, the Assessing Officer on earlier occasion has held that the assessee as the 'assessee in default' under section 201 for failure to deduct tax on similar payments. Learned CIT(A) by order dated 27-2-2004 has confirmed the action of Assessing Officer. The assessee challenged the order of learned CIT(A) dated 27-2-2004 before this Tribunal. The Tribunal by its order in ITA Nos. 864 865/Bang./2004, dated 28-4-2005 following the decision of Income-tax Appellate Tribunal in the case of Samsung Electronics. Co. Ltd. v. ITO in ITA Nos. 264 to 266 dated 18-2-2005, [2005] 94 ITD 91 (Bang.) held that the amount paid by assessee is for purchase of goods and not towards payment of royalties. The payment is for use of copyrighted article and not to acquire any copyrights in such articles. Thus the payment was not treated as payment for royalty within the meaning of Explanation 2 to section 9(1)(vi) of the Act. It was held that ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ers in India without opening the package. The assessee acquires during the course of business a copyrighted article whereas the copyright remains with the owner or the seller. What the assessee acquires is the material object available off the shelf which is different from copyright. The assessee has mainly obtained the right to distribute the copyrighted material, which is different from ownership of the copyright in the software. The assessee considered the incomes represented by these payments to be business profits of the non-resident taxable only under Article 7 of respective Double Taxation Avoidance Agreements (DTAA), if there was a permanent establishment in India of the non-residents in India. In the absence of a P.E., the assessee considered the payments as not chargeable to tax in India and therefore outside the purview of tax deduction under section 195. According to the Assessing Officer the payments are covered by definition of 'Royalty' under section 9(1)(vi) of the Act and therefore section 195 applies in this case. The Assessing Officer thus held these payments, fall within the purview of section 9(1)(vi) of the Act, since the import of software packages do ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ocess' or 'Scientific Work' or 'Patent'. He thereafter submitted that as per the decisions given by the High Courts and Supreme Court, 'the Tribunal is under the obligation to give findings on the arguments advanced by the parties' as held in - a. CIT v. G.M. Mittal Stainless Steel Ltd. [2004] 271 ITR 219 (MP) b. Udhavdas Kewalram v. CIT [1967] 66 ITR 462 (SC) c. E.A. Venkataramier Sons v. CIT [1967] 65 ITR 316 (Mad.) d. CIT v. Hyderabad Secunderabad Foodgrains Association Ltd. [1989] 175 ITR 574 (AP) e. A. Venkata Rao v. CIT [1993] 203 ITR 64 (Ori.) In view of the above position of law, Sri Korde requested that, the Bench may kindly give findings on the submission made by the Department. In the cases of Samsung Electronics Co. Ltd. and Motorla Inc. v. Dy. CIT [2005] 95 ITD 269 (Delhi) (SB) have decided the case in which assessee-companies had imported software for their own use. In those cases, the Tribunal has laid down that payment for copy of software made by the Indian company to the foreign company was for the copyrighted article and was not for use of copyright. Therefore, such payment cannot be considered as a 'royalty' either under the I ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f US Copyright Act, unauthorised sale or distribution of computer software is prohibited. Similarly under section 23 of Designs and Patents Act, 1988 of U.K, unauthorised sale or distribution of computer software is prohibited. Hon'ble Delhi High Court in the case of Penguin Books Ltd. v. India Book Distributors AIR 1985 Delhi 29 held that sale of imported copies of book by an Indian Distributor without license to do so infringes UK publishers copyright. The Special Bench of Income-tax Appellate Tribunal, Delhi in the case of Motorola Inc. held that right to sale and distribute computer software is available only to the owner of the computer software. Since the assessee has distributed the software, the assessee or the ultimate payee can be said to have acquired the copyright or right to use the copyright and hence to be treated as payment for royalty within the meaning of Explanation 2 to section 9(1)(vi) of the Act. 4.2 Alternatively, lump sum payment is to be apportioned towards taxable portion as royalty and non-taxable portion as cost of goods as royalty payment is embedded in total consideration of software. Difficulty in apportionment cannot be a ground for non-apportion ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tented article would fall within the definition of Royalty payment. Since one of the rights of the patent holder is the right to use the invention (apart from the right to make or vend), which he can license to others. Softwares are entitled to Patents which is evidenced from thousands of Softwares have been patented all over the world. Patent gives an exclusive right to inventor to use make and/or vend his patented article. In Patent Law, the Patentee gets, inter alia, an exclusive right to sue the article (on which he has the Patent). This exclusive right (to use) can be transferred to others either by selling the product (where an ownership is transferred) or thought a license agreement, allowing the license to use the article for a consideration. Hence, it is absolutely correct to say that payment made for the use of patented article is for the use of patent since physical use of the article (which is patented) is a right vested to patentee by Patent Law. In respect of Software, which is patented, the same can be licensed for physical use. And as discussed earlier, the right to physically use the article (which is patented is one of the rights embedded in the Patent Rights. The ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... create by thought, devise, originate a new method, an instrument, etc .... and inventions means the process of inventing, a thing invented). These softwares are not routine, run-of the mill kind of programmes but are highly sophisticated and complex, which require investments in millions of dollar and hundreds of man-hours for development. An inventor's property rights in the invention may be transferred by granting a license to use his invention on Royalty. Consideration paid for the use of invention - The expression used in the definition of 'Royalty' means consideration paid inter alia, for the physical use of an innovative article or an innovative process. Since a patent as per Patent Law can be given only to an invention, and the very fact that tens of thousands of softwares have been patented, it can only mean, that there is no stretching and over stating the meaning of the word invention when applied in the context of software . When a person pays thousands of dollars for acquiring the license to use software, he does not make payments of such amounts for simple run-of the mill programmes which do some simple arithmetic calculations. Instead, these softwares rep ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he user the formula (in form of the logic of the software) actually remain secret since the use is unable to decipher the object code. It may also be mentioned here that Canada (which is a part of OECD) has not accepted the OECD Model Convention in respect of tax treatment of software purchases. In Canada payments by sue of software are payments for the use of secret formula or process and thus are royalties. Similarly, countries like Spain, Greece, Portugal (who are part of OECD) have reserved the rights to tax the software income as royalties. It may also be mentioned here that many companies in India (including some MNCs) have been regularly deducting tax on their own on such remittances treating them as royalty payments. 4.7 Shri Korde ultimately submitted that what is taxed as royalties is the amount received as consideration for the use or the right to use, and not outright purchase of the right to use, an asset. Royalty is thus a consideration, including a lump sum consideration, for the transfer of all or any right (including the granting of all license) in respect of a copyright, patent, trademark, design and mode, or secret formula, etc. transfer of the right in the prope ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... roperty is necessary. The said distinction has been recognized and given effect to in the following judicial pronouncements: Hon'ble Calcutta High Court in the case of CIT v. Davy Ashmore India Ltd. [1991] 190 ITR 626 held thus: The term 'royalty' has been defined in the agreement to mean, inter alia, the payment of any kind including rentals received as a consideration for the use of or the right to use any patent, trademark, design or model, plan, secret formula or process. It is important-that in order that a payment may be treated as royalty for the purposes of article XIII of the Agreement for Avoidance of Double Taxation between India and the U.K, the person who is the owner of such patents, designs or models, plans, secret formula or process, etc. retains the property in them and permits the use or allows the right to use such patents, designs or models, plans, secret formula, etc. In other words, where the transferor retains the property right in the, designs, secret formula, etc., and allows the use of such right, the consideration received for such user is in the nature of royalty. Where, however, there is an outright sale or purchase, the consideration is for ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... there is no transfer of any right including granting of a licence in respect of such computer programme and hence cannot be considered as royalty within the meaning of Explanation 2 to section 9(1)(vi) of the Act. 6. We have carefully considered the relevant facts, argument advanced and decisions cited. It is agreed by both the counsels that the issue is covered in ITA Nos. 864 868/Bang./04, dated 28-4-2005 in assessee's own case. However, since it is the contention of learned D.R. that the issue is to be examined whether the payment is covered as royalty whereunder clause (i) or under clause (v) of Explanation 2 to section 9(1)(vi) of the Act, we shall deal with the same. It is also clear that no contrary decision has been cited before us. However, to rest the matter we shall deal with all the argument raised by learned D.R. The words computer programme is not defined except under the Copyright Act, 1957. As canvassed by learned counsel for assessee the computer programme are not protected under the Patent Act. Clause (i) of Explanation 2 to section 9(1)(vi) applies to transfer of all or any rights including the granting of a license in respect of patent, invention, model, des ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r Exhibit 1 to the agreement is regarding Product Ordering and Delivery Terms, Exhibit 2 Product Return Terms, Exhibit 3 General Provisions Applicable in Territory, Exhibit 4 Territory Specific Tax Provisions, Exhibit 5 - Notices, Exhibit 6 - Confidentiality Terms. Clause 4 of this Exhibit reads as under: 4. Miscellaneous: (a) All Confidential Information and Confidential Materials are and shall remain the property of MRS. By disclosing information to Company, MRS does not grant any express or implied right to Company to or under Microsoft patents, copyrights, trademarks, or trade secret information. (b) If MRS or any MRS affiliate provides pre-release PC operating system software ( Product ) as Confidential Information or Confidential Materials under this Agreement: (i) such Product is provided as is without warranty of any kind; and (ii) Company agrees that neither MRS nor its suppliers shall be liable for any damages, injury or loss whether direct or indirect, and whether arising at law; by statute, in equity or otherwise arising from the relationship between the parties, relating to Company's use of such Product; and (iii) this Agreement shall not extend beyond (a) the comm ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ent will inure to the benefit of and be binding upon the parties, their successors and assigns. (g) If any provision of this Agreement shall be held by a court of competent jurisdiction to be illegal, invalid or unenforceable, the remaining provisions shall remain in full force and effect. (h) All obligations created by this Agreement shall survive change or termination of the parties' business relationship . A perusal of the above agreement indicates that in all the cases the copyright is retained with the owner and only the copyrighted article has been sold to the Distributor (the Appellant) for distribution in India. 6.2 At this juncture, it is made clear that all the impugned appeals are filed suo motu under section 248 of the Income-tax Act. Thus, the appellant has been deducting tax at source and filing an appeal before Commissioner of Income-tax under protest. The main reason for arriving at such a conclusion is that the Assessing Officer was of the view in the past as per the order under section 201(1) dated 31-1-2003 that the appellant ought to have deducted tax at source under section 195 of the Income-tax Act on the ground that the payments made to these parties were ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... de for the use of software for a fixed period, it would constitute royalty. He thereafter referred to software in the context of the ruling of an Australian Court which held that the amount received in respect of Computer software would not be royalty if it does not give any rights in the copyrights. He has however not followed that reasoning to the appellant without giving any reasons. He has thereafter dealt with the contention that the software constitutes goods. According to the Assessing Officer software does not constitute goods . Accordingly he has directed that tax on royalty under section 195 ought to be deducted at the rates specified in his order. 6.3 The question which arises is whether the payments made by the appellant for distribution of the software acquired from the Vendors can at all be considered to be the payment made in respect of 'Royalty' within the meaning of Explanation 2 to section 9(1)(vi) of the Income-tax Act, 1961. The further question which arises is whether in respect of countries where India has entered into agreements for avoidance of double taxation, the payments fall within the scope of the term royalty under such DTAA. The Assessing Offi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f any such right, property or information; (b) any industrial, commercial or scientific equipment, other than payments derived by an enterprise from activities described in paragraph 4(b) or 4(c) of Article 8. USA Article 12 - Royalties and fees for included services - 1. 2. **** 3. The term royalties as used in this Article means: (a) payments of any kind received as a consideration for the use of, or the right to use, any copyright or a literary, artistic, or scientific work, including cinematograph films or work on film, tape or other means of reproduction for use in connection with radio or television broadcasting, any patent, trademark, 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 or property which are contingent on the productivity, use, or disposition thereof; and (b) payments of any kind received as consideration for the use of or the right to use, any industrial, commercial, or scientific equipment, other than payments derived by an enterprise described in paragraph 1 of Article 8 (Shipping and Air Transport) from activities desc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... endering of any services (including those of technical or other personnel), which make available technical knowledge, experience, skill, know-how or processes or consist of the development and transfer of a technical plan or design; but the term does not include payments or credits relating to services mentioned in sub-paragraphs (d) and (g) that are made: (h) for services that are ancillary and subsidiary, and inextricably and essentially linked, to a sale of property; (i) for services that are and ancillary and subsidiary to the rental of ships, aircraft, containers or other equipment used in connection with the operation of ships or aircraft in international traffic; (j) for teaching in or by an educational institution; (k) for services for the personal use of the individual or individuals making the payments or credits; or (l) to an employee of the person making the payments or credits or to any individual or firm of individuals (other than a company) for professional services as defined in Article 14. Broadly the aforesaid definitions cover the payments for the use or a right to use intellectual property rights specified therein or for certain specified categories of equipment ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ition of a computer is possible or available because the type of computer functions, capacities and technology involved is rapidly changing. A simple definition is A device that receives, processes and presents information (See Mcgraw Hill Concise Encyclopaedia of Science and Technology). There are two basic types of computers; namely, analog and digital. For the purposes of the Copyright Law the distinction between the two types is not material. Copyright Law is interested in the computer software and not in the computer itself. 3.63 Computer programme.-Computer programme has been held to be 'literary work' written down, recorded or otherwise reduced to material form. Copyright subsists in a computer programme provided sufficient effort or skill has been expended to give it a new and original character. However, a computer programme which does no more than produce the multiplication tables, or the alphabet, cannot lay claim to copyright protection. That is because the amount of skill or effort entailed in such an exercise is too trivial to render the resultant work something which is new and of original character. 3.64 Statutory definition of computer programme.- Computer ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e used. It was further held that an object code is an adaptation or mechanical translation of the source code within the meaning of the copyright law and copying of the object code was an infringement of the copyright in the source code. An appeal was allowed holding; (1) the source code of each programme was an original literary work; (2) the object code of a programme was not itself a literary work, for they are merely electrical impulses in a silicon chip, which could neither be perceived by the senses nor were intended to convey and message to a human being and which did not represent words, letters figures or symbols and therefore could not be described as literary work. A pattern of circuits is also in the same position, (3) the object code is not a translation within the primary meaning of that word, and (4) the object code is not the rendering of the source code in another medium (adopting the secondary meaning of the word 'translation'). See Computer Edge v. Apple Computer [1986] FSR 537. In the United States it has been held that an object code is entitled to copyright protection, see Apple Computer v. Franklin Computer [1983] 714 F 2nd 1240, referred to in Comput ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... wo dimensional work or in two dimensions of a three dimensional work; (ii) to communicate the work to the public; (iii) to issue copies of the work to the public not being copies already in circulation; (iv) to include the work in any cinematograph film; (v) to make any adaptation of the work; (vi) to do in relation t6 an adaptation of the work any of the acts specified in relation to the work in sub-clauses (i) to (iv); (d) in the case of a cinematograph film,- (i) to make a copy of the film, including a photograph of any image forming part thereof; (ii) to sell or give on hire, or offer for sale or hire, any copy of the film, regardless of whether such copy has been sold or given on hire on earlier occasions; (iii) to communicate the film to the public; (e) in the case of a sound recording,- (i) to make any other sound recording embodying it; (ii) to sell or give on hire, or offer for sale or hire, any copy of the sound recording regardless of whether such copy has been sold or given on hire on earlier occasions; (iii) to communicate the sound recording to the public. Explanation: For the purposes of this section, a copy which has been sold once shall be deemed to be a copy alrea ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... is is so even if the goods were manufactured by the copyright owners' licensee. But this is only the consequence of chattel ownership and nothing in the nature of a licence is involved. The buyer of a book in which copyright exists is just such a buyer; the book, once bought by him, is not thereafter subject to any monopoly rights of the copyright owner but may be dealt with by the buyer entirely as he chooses. The copyright in the literary work of course remains with the copyright owner; the buyer has bought no part of it and remains as he was before his purchase, unable lawfully to enjoy any of those exclusive rights, reproduction, adaptation or the like, which ownership of the copyright preserves exclusively for the copyright owner. 7.4 Multiple nature of right.- Copyright is not a single right but a bundle of rights which can be exploited independently. Further the nature of these rights depends upon the categories of works. There are four categories of works on which copyright subsists, namely: (1) original literary, dramatic and musical works, (2) original artistic works, (3) cinematograph films, and (4) sound recording. The exclusive right conferred by the Act on these c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on earlier occasions; to sell or give on hire, or offer for sale or hire, any copy of the sound recording regardless of whether such copy has been sold or given on hire on earlier occasions; The genesis of these special rights to these three categories of rights has been explained in Intellectual Property Law by Lionel. Bently Brad Sherman Oxford Indian Edition at pages 43, 44, 130, 132 in the following terms: 7.1 Computer Programmes Directive (1991).- The first European initiative in the copyright field was the Computer Programmes Directive, which had to be implemented by 1-1-1993. The Computer Programmes Directive addressed the question of whether computer programmes should be protected by copyright, patents or a sui generis right. Fearing that the member States might have responded differently, the Commission sought a swift and unified response. After consulting with interested parties, it was decided that computer programmes should be protected by copyright. This is reflected in the act that the Directive requires member States to protect computer programmes as literary works under the Berne Convention. To ensure that this operates as a matter of substance as well as form, the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Berne Convention), performers, phonogram producers, and film producers the exclusive right to control the rental and lending of copies (or in the case of performers, fixations) of their works. However, member States are given a number of options: sometimes in derogation from the exclusive rights. The most important of these is the option not to recognize an exclusive right to authorise 'public lending' if authors receive remuneration of some sort for such lending. Member States may also exempt certain establishments from the payment of remuneration for lending. Chapter 1 of the Directive also includes some interesting provisions on the ownership of the rental right. The Directive recognized the need for creators to obtain an 'adequate income as a basis for further creative and artistic work'. As a result, a fiercely debated provision requires member States to confer on authors and performers and 'unwaivable right to equitable remuneration' when copies of films or phonograms are rented. In turn, it was decided that this required further definition of who is the author of a cinematographic or audiovisual work (a matter on which there are wide divergences under ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rlands and then imported into end sold in the UK, the importation and sale in the UK does not infringe the issuing right. This might even be the case if the copy placed on the market in the Netherlands is an infringing copy. (However, in these circumstances the importation may constitute a secondary infringement). In contrast, since there is no international exhaustion, the issuing right may be invoked to prevent the parallel importation into the UK of copies marketed outside the EEA by or with the consent of the relevant copyright owner'. 4. Rental and lending rights.-While subsequent distribution of copies of the work is not generally within the copyright owner's control, the owner of the copyright does have the right to control the rental and lending of the work. When the 1988 Act was first enacted, it provided a limited right to control the rental of copies of sound recordings, films, and computer programmes. No such right was given in relation to literary, dramatic, musical or artistic works. However, as a result of amendments implementing the Rental Rights Directive, copyright in literary, dramatic or musical works, as well as artistic works (other than works of archi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... that member of the public from reselling the book. This is so because the right of distribution exhausts itself when the book is originally sold. However, with regard to cinematograph film, sound recording and computer programmes an additional right is conferred viz., to sell or give on commercial rental or offer for sale or for commercial rental any copy of the computer programme or film or sound recording. The question arises as to why this distinction is drawn between these three categories of work and literary, dramatic, musical or artistic works? The genesis of this additional right being conferred is to be found in the development of the history of an International Copyright Law. The five most significant treaties in International Copyright Law which have contributed to the development of Copyright Law are:- (1) Berne Convention (2) Rome Convention (3) TRIPS (4) WIPO Copyright Treaty (5) WIPO Performances and Phonograms Treaty In the Berne Convention which was revised several times certain minimum standards of protection to copyright owners and authors. These included the right to reproduce the work, to perform the work publicly, to translate the work, to adapt the work, and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... horise or to prohibit the commercial rental to the public of originals or copies of their copyright works. A Member shall be expected from this obligation in respect of cinematographic works unless such rentals has led to widespread copying of such works which is materially impairing the exclusive right of reproduction conferred in that Member on authors and their successors in title. In respect of computer programmes, this obligation does not apply to rentals where the programme itself is not the essential object of the rental . Article 14 Protection of Performers, Producers of Phonograms (Sound Recordings) and Broadcasting Organisations 1. to 3. 4. The provisions of Article 11 in respect of computer programmes shall apply mutatis mutandis to producers of phonograms and any other right-holders in phonograms as determined in domestic law. If, on the date of the Ministerial Meeting concluding the Uruguay Round of Multinational Trade Negotiations, a Member has in force a system of equitable remuneration of right-holders in respect of the rental of phonograms, it may maintain such system provided that the commercial rental of phonograms is not giving rise to the material impairment of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e copyright owner. This is without prejudice to the pre-existing rule as to rental of computer programmes, sound recordings and films being deemed to be within the restricted act of issuing copies to the public. New section 18A of the Copyright, Designs and Patents Act, 1988 contains the detail. The new restricted act is wider than the previous and continuing 'rental right' in that it applies to greater number of types of works and lending also is covered. Now, for example, renting a copy of a database of modem art to the public is a restricted act. Both rental and lending are defined on the basis that a copy of the work (which includes the original) is made available for use on terms that it will or may be returned. Unlike lending, rental is for direct or indirect economic or commercial advantage. Lending under the Public Lending Right Act, 1979 does not infringe. There are provisions for transfer of the rental right in the case of works included in films or sound recordings. These could be relevant in terms of works included in multimedia encyclopaedia. The author of a work in which rental right subsists has, upon transfer of his or her right, a right to an equitable remu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... , of any unauthorised copying or copies of Products which come to the Distributor's attention. (j) Refrain from making copies of any diskettes or documentation related to any Microsoft software product for any purpose without the prior written consent of MO, MRS or Microsoft Corporation. It is, therefore, clear that none of the exclusive rights in a work have been transferred to the appellant. The exclusive rights in a work are the reproduction right, distribution right, rental or lending right etc. These rights have not been transferred to the appellant. What all the appellant is doing is using the software and/or acting as a distributor of the software. This brings up the question as to whether there is a distinction between the transfer of a copyright per se and a copyrighted article. The Author, P. Narayanan in Copyright and Industrial Designs Third Edition at page 79 draws a distinction between copyright in a work and the ownership of the physical material in which the work is fixed. Three paragraphs paras 6.1, 10.1 and 10.5 are reproduced below: 6.1 Who is the owner.-Ownership of copyright in a work is quite independent of the ownership of the physical material in which t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... pyright and ownership of the work:- Ownership of the copyright in a work is not the same as ownership in the material object in which the copyright work is embodied. Thus a person who buys a painting may be the owner of the canvas in which the painting is drawn but the copyright in the work may vest in the artist who has drawn the painting. Similarly if a person buys a book he is the owner of the book but he has no right to reproduce the work or publish an abridgement or translation of the work. That right belongs to the author or the copyright owner of the book. Iyengar in Copyright Act, 1957 also draws a distinction between the material object which is the subject of copyright and the copyright itself on page 198 of his commentary which reads as under: 7. Material object which is the subject of copyright is different from copyright.- Copyright is different from the material object, which is the subject of the copyright. So, a transfer of the material object does not necessarily involve a transfer of the copyright. Where the plaintiffs sold certain electro blocks for the purpose of printing certain drawings, and the purchasers lent these blocks to the defendants in order that they ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ftware is downloaded. Thus when the appellant is a distributor for Acutate Asia Pacific, Clad era or Microsoft, he has not acquired the distribution right which is a copyright within the meaning of section 14(a)(ii) or the right to sell or give on commercial rental or offer for sale or for commercial rental computer programmes which is a right under section 14(b)(ii) which continues to remain with Computer Associates Microsoft. The appellant has merely obtained the right to distribute the copyrighted material which is a property different from the property in the copyright in the software. The property contained in copyrighted material and the property contained in the copyright to software are two different rights and when the assessee acts as a distributor for copyrighted material, he has not acquired the distribution right within the meaning of section 14(a)(ii) read with section 14(b)(ii) of the Copyright Act, 1957. If this distinction is not kept in mind the consequence would be something as follows. According to the Assessing Officer the appellant has acquired the copyright, say, Microsoft Office 2000 (a computer programme owned by the Microsoft). If the Assessing Officer is ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ads to absurd conclusions such an interpretation must be eschewed and rejected. Therefore, when one refers to the agreement, it must be read in the context of what is the right sought to be transferred and the rights sought to be retained by keeping it outside the purview of the agreement. 6.8 Assuming for the sake of argument that copyright has been transferred as contended by the Assessing Officer the requirements of law as to assignation of copyrights have not been complied with. Section 18 and section 19 of the Copyright Act, 1957 read as under:- 18. Assignment of copyright.-(1) The owner of the copyright in an existing work or the prospective owner of the copyright in a future work may assign to any person the copyright either wholly or partially and either generally or subject to limitations and either for the whole of the copyright or any part thereof: Provided that in the case of the assignment of copyright in any future work, the assignment shall take effect only when the work comes into existence. 2. Where the assignee of a copyright becomes entitled to any right comprised in the copyright, the assignee as respects the rights so assigned, and the assignor as respects the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ference between assignment of a copyright and a mere sale or transfer of the work itself is brought out by Lionel Bently and Brad Sherman in Intellectual Property Law Oxford Indian Edition at page 255 in the following terms: In order for an assignment to be valid, it must be in writing and signed by or on behalf of the assignor. It has been held that sufficient writing might be provided by an invoice or receipt. The assignment should identify the work concerned with sufficient clarity so that it can be ascertained, though the courts have admitted oral ('parol') evidence to assist in the process of identification. No special form of words is required, so a transfer of 'all the partnership assets' will include a transfer of any copyright owned by the partnership. Assignment of copyright is a distinct legal transaction and is not effected by mere sale or transfer of the work itself. Thus, if a person sells an original painting or manuscript, this (of itself) only transfers the personal property right in the chattel: the copyright remains with its owner. If a vendor wishes to transfer the copyright as well as the personal property in the chattel, this should be done exp ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the Supreme Court had to deal with the question as to whether the software contained on computer disc could be regarded as goods. Under the Custom Act duty was payable on software whether contained on a floppy disc, cartridge tape, on disc or on CD ROM or otherwise. It was argued for the assessee that the transaction between the appellant and the foreign collaborator was for transfer of technology. It was submitted that even Government authorities regarded it as a contract for service and not for sale of goods and in this regard reliance was placed on the fact that the Reserve Bank of India had required an application to be made for permission to remit foreign exchange in Form A2 which was meant for foreign exchange remittances otherwise than for import of goods. The Court rejected this contention. After setting out the relevant provisions the Supreme Court concluded in para 33 as under: 33. It is true that what the appellants had wanted was technical advice or information technology. Payment was to be made for this intangible asset. But the moment the information or advice is put on a media, whether paper or diskettes or any other thing, that what is supplied becomes chattel. It i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tly required for delivery to license sites. The terms of the agreement also apply to the copies. This question has arisen also in the US in South Central Bell Telephone Co. v. Sidney J. Barthelemy. The Supreme Court of Louisiana had to consider the question in the context of the liability to the city use tax . The relevant statutes read as under:- The city use tax is imposed by $ 56-21 of the Code of the City of New Orleans; There is hereby levied, for general municipal purpose, a tax upon the sale at retail, the use, the consumption, the distribution and the storage for use or consumption in the city of each item or article of tangible personal property, upon the lease or rental of such property and upon the sale of services within the city ... [Personal property which may be seen, weighed, measured, felt or touched, or is in any other manner perceptible to the senses. The term tangible personal property shall not include stocks, bonds, notes or other obligations or securities ..... The pertinent Civil Code provisions are Louisiana Civil Code articles 461, 471 and 473. Article 461 distinguishes between corporeals and incorporeals providing: **1244 Corporeals are things that have a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rmation Shontz, supra, at 162, 167. When stored on magnetic tape, disc or computer chip, this software or set of instructions, is physically manifested in machine-readable form by arranging electrons, by use of an electric current, to create either a magnetized or unmagnetized space. Donald H. Sanders, Computers Today, 229, 233 [1988]; Stohigren supra, at 105. The computer reads the pattern of magnetized and unmagnetized spaces with a read/write head as on and off , or to put it another way. 0 and I [FN4]. This machine-readable language or code is the physical manifestation of the information in binary form. Sanders, supra at 167,233; Stohigren, supra, at 105. FN4. Though not at issue in this case. CD - ROM storage devices work on a similar concept as magnetic storage devices, but instead of using an arrangement of magnetic and unmagnetic spaces, information is stored by burning or pressing tiny pits into a thin coating of metal or other material deposited on the disk, which is then read by use of a laser light. Sanders, supra, at 241. *12 Ordinarily, at least three programme copies exist in a software transaction: (i) an original, (ii) a duplicate and (iii) the buyer's final c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... recorded and stored in physical form upon a physical object. See Crockett, supra, at 872-74; Shontz, supra, at 168-70: Cowdrey, supra at 188-90. As the court of appeal explained and as Bell readily admits the programmes cannot be utilized by Bell unit they have been recorded into the memory of the electronic telephone switch. 93-1072 at p. 6. 631 So. 2 d at 1343. The essence of the transaction was not merely to obtain the intangible knowledge or information but rather, was to obtain recorded knowledge stored in some sort of physical form that Bell's computers could use. Recorded as such the software is not merely an incorporeal idea to be comprehended and would be of no use if it were. Rather, the software is given physical existence to make certain desired physical things happen. One cannot escape the fact that software, recorded in physical form, becomes inextricably intertwined with or part and parcel of the corporeal object upon which it is recorded, be that a disk, tape hard drive or other device. Crockett, supra, at 371-72, Cowdrey, supra at 188-90. That the information can be transferred and then physically recorded on another medium and does not make computer software ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... re is sufficient memory space available in the computer hard disc drive such movies, books, music, etc.... can all be recorded into the permanent memory of the computer such as was done with the software in this case. 93-1072, at p. 4-5, 631 So. 2 d at 1346-47 [dissenting opinion]. See also Shontz. supra, at 168-170: Harris, supra at 187. That the information knowledge, story, or idea, physically manifested in recorded form can be transferred from one medium to *15 another does not affect the nature of that physical manifestation as corporeal, or tangible. Shontz, supra at 168-170 Likewise, that the software can be transferred from, **1248 one type of physical recordation, e.g., tape, to another type, e.g., disk or hard drive, does not alter the nature of the software, Shontz. supra, at 168-170: it still has corporeal qualities and is inextricably intertwined with a corporeal object. The software must be stored in physical form on some tangible object somewhere. Shontz, supra, at 169; Crockett, supra, at 871-72; Harris, supra, at 187 n. 149. The software was reduced to physical form and recorded on a tangible object prior to delivery to Bell and Bell maintained the software in phys ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f positive and negative prints of photoplays with the license to use or exhibit them for a specified time. The license to exhibit without the *18 transfer of possession would be valueless. 193 So at 712 [quoting United Artist Corp. v. Taylor 273 N.Y. 334, 341, 7 N. 2 d 254, 256 (1937)]. Hence, we found that the license to exhibit the films was inseparable from the tangible film prints. Likewise the license to use the software, without transferring the software, would be of no use to Bell and the license to use the software is inseparable from the physical manifestation of the software in recorded form ...... In sum, once the information or knowledge is transformed into physical existence and recorded in physical form, it is corporeal property. The physical recordation of this software is not an incorporeal right to be comprehended. Therefore we hold that the switching system software and the data processing software involved here is tangible personal property and thus is taxable by the City of New Orleans. In Hasbro Industries Inc. (487 A. 2d 124) Supreme Court of Rhode Island had to consider a similar provision which reads as under: Use taxes are imposed on the storage, use or oth ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... that the transactions under the Distributor Agreements are transaction of purchase of goods/software products, Circular No. 23, dated 23-7-1969 of the CBDT comes into picture which clarifies that when a non-resident entity supplies goods from outside India on FOB basis then the profits on such sale do not accrue or arise in India and accordingly such profits are not liable to tax in India under the Act. This clarification has been reiterated in recent CBDT Circular No. 786 [242 ITR 132]. 6.10 A similar view has been taken by the OECD in its model commentary in paras 12 to 17 dealing with the payment of software which read as under:- 12. Whether payments received as consideration for computer software may be classified as royalties poses difficult problems but is a matter of considerable importance in view of the rapid development of computer technology in recent years and the extent of transfers of such technology across national borders. In 1992, the Commentary was amended to describe the principles by which such classification should be made. Paragraphs 12 to 17 were further amended in 2000 to refine the analysis by which business profits are distinguished from royalties in comp ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rtial rights or complete rights in the underlying copyright (see paragraphs 13.1 and 15 below), or they may be (or be equivalent to) partial or complete rights in a copy of the programme (the programme copy ), whether or not such copy is embodied in a material medium or provided electronically (see paragraphs 14 to 14.2 below). In unusual cases, the transaction may represent a transfer of know-how or secret formula (paragraph 14.3). 13.1 Payments made for the acquisition of partial rights in the copyright (without the transferor fully alienating the copyright rights) will represent a royalty where the consideration is for granting of rights to use the programme in a manner that would, without such license, constitute an infringement of copyright. Examples of such arrangements include licenses to reproduce and distribute to 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). It should be noted that where a software payment is properly t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 7. 14.1 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 disk 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. 14.2 The ease of reproducing computer programmes has resulted in distribution arrangements in which the transferee obtains rights to make multiple copies of the programme for operation only within its own business. Such arrangements are commonly referred to as site licences , enterprise licenses , or network licences . Although these arrangements permit the making of multiple copies of the programme, such rights are generally limited to those necessary for the purpose of enabling the operation of the programme on the licensee's computers or network, and reproduction for any other purpose is not permitted under the license. Payments under such arrangements will in most cases be dealt with as business profits in accordance with Article 7. 14.3 Another type of transaction involvi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed to each apportioned part. 17.1 The principles expressed above as regards software payments are also applicable as regards transactions concerning other types of digital products such as images, sounds or text. The development of electronic commerce has multiplied the number of such transactions. In deciding whether or not payments arising in these transactions constitute royalties, the main question to be addressed is the identification of that for which the payment is essentially made. 17.2 Under the relevant legislation of some countries, transactions which permit the customer to electronically download digital products may give rise to use of copyright by the customer, e.g.) because a right to make one or more copies of the digital content is granted under the contract. Where the consideration is essentially for something other than for the use of, or right to use, rights in the copyright (such as to acquire other types of contractual rights, data or services), and the use of copyright is limited to such rights as are required to enable downloading, storage and operation on the customer's computer, network or other storage, performance or display device, such use of copyr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d as royalties poses difficult problems but is a matter of considerable importance in view of the rapid development of computer technology in recent years and the extent of transfers of such technology across national borders. Software may be described as a programme, or series of programmes, containing instructions for a computer required either for the operational processes of the computer itself (operational software) or for the accomplishment of other tasks (application software). It can be transferred through a variety of media, for example in writing, on a magnetic tape or disc, or on a laser disc. It may be standardised with a wide range of applications or be tailor-made for single users. It can be transferred as an integral part of computer hardware or in an independent form available for use on a variety of hardware. The rights in computer software are a form of intellectual property. Research into the practices of OECD Member countries has established that all but one protect software rights either explicitly or implicitly under Copyright Law. Transfers of rights occur in many different ways ranging from the alienation of the entire rights to the sale of a product which i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ographical area; - additional consideration related to usage; - consideration in the form of a substantial lump sum payment. [Para 15] Each case will depend on its particular facts but in general such payments are likely to be commercial income within Article 7 or 14 or a capital gains matter within Article 13 rather than royalties within Article 12. That follows from the fact that where the ownership of rights has been alienated in full or in part, the consideration cannot be for the use of the rights. The essential character of the transaction as an alienation cannot be altered by the form of the consideration, the payment of the consideration in instalments or, in the view of most countries, by the fact that the payments are related to a contingency. [Para 16] The third situation is where software payments are made under mixed contracts. Examples of such contracts include sales of computer hardware with built-in software and concessions of the right to use software combined with the provision of services. The methods set out in paragraph 11 above for dealing with similar problems in relation to patent royalties and know-how are equally applicable to computer software. Where nece ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... a use of copyright. Category 2: Electronic ordering and downloading of digital products: Definition - The customer selects an item from an online catalogue of software or other digital products and orders the product electronically directly from a commercial provider. There is no separate charge to the customer for using the online catalogue. The digital product is downloaded onto the customer's hard disk or other non-temporary media. 3. Analysis and conclusions.-The Group found that this category of transaction raised the fundamental characterisation issue discussed in paragraphs 13 to 15 of section 3 above, i.e., the distinction between business profits and the part of the treaty definition of royalties dealing with payments for the use of, or the right to use, a copyright. It concluded that in the case of transactions that permit the customer to electronically download digitised products (such as software, images, sounds or text) for the customer's own use or enjoyment, the payment is made to acquire data transmitted in the form of a digital signal. Since this constitutes the essential consideration for the payment, that payment cannot be considered as royalties as a pa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s described in category 2 above if the updates and adds-on are delivered electronically. 6. Since both categories 1 and 2 would give rise to payments falling under Article 7, payments made by the customer in this category of transaction should therefore be treated similarly. Category 5: Limited duration software and other digital information licenses: Definition - The customer receives the right to use software or other digital products for a period of time that is less than the useful life of the product. The product is either downloaded electronically or delivered on a tangible medium such as a CD. All copies of the digital product are deleted or become unusable upon termination of the license. 7. Analysis and conclusions.-The Group unanimously concluded that, under the GECD Model as currently worded, that transaction should be treated exactly as transactions falling under categories 1 or 2 so that the payment to the commercial provider of the limited duration digital product would fall under Article 7 (Business Profits). 8. Also, if a particular convention includes a definition of royalties that covers payments for the use of, or the right to use, industrial, commercial or scien ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... TAA intended a different interpretation and such different interpretation is made express by way of protocol or by any other means, or (iii) the relevant member country has recorded its reservations in the Model Commentaries in relation to particular interpretation. This principle has been expressly spelt out both under UN Model Commentary as well as OECD Model Commentary. In this connection, UN Model Commentary, in its clauses 34 and 36 to introduction, observes as under: 34. The rationale of the preparation of bilateral tax conventions was cogently expressed by the Fiscal Committee of the League of Nations in the following terms: 'The existence of model draft treaties... has proved of real use ... in helping to solve many of the technical difficulties which arise in [the negotiation of tax treaties]. This procedure has the dual merit that, on the one hand, insofar as the model constitutes the basis of bilateral agreements, it creates automatically an uniformity of practice and legislation, while, on the other hand, inasmuch as it may be modified in any bilateral agreement reached, it is sufficiently elastic to be adapted to the different conditions obtaining in different coun ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... increasingly using the Commentaries in reaching their decisions. Information collected by the Committee on Fiscal Affairs shows that the Commentaries have been cited in the published decisions of the courts of the great majority of Member countries. In many decisions, the Commentaries have been extensively quoted and analysed and have frequently played a key role in the Judge's deliberations. The Committee expects this trend to continue as the world-wide network of tax treaties continues to grow and as the Commentaries gain even more widespread acceptance as an important interpretative reference. 30. Observations on the Commentaries have sometimes been inserted at the request of Member countries that are unable to concur in the interpretation given in the Commentary on the Article concerned. These observations thus do not express any disagreement with the text of the Convention, but usefully indicate the way in which those countries will apply the provisions of the Article in question. 6.12 The Assessing Officer had further referred to certain rulings from US, Australia and Singapore Authorities in respect of software imports. These are dealt with below: Singapore The Assessin ..... X X X X Extracts X X X X X X X X Extracts X X X X
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