The Software Royalty Issue

Dy. Director of Income Tax v. Reliance Industries Ltd, Hon'ble ITAT Mumbai

Date of Decision: 29/10/2010

The decision was rendered a day after the Microsoft Judgment by the Hon'ble ITAT, Delhi Bench. The issue of software royalty may require reconsideration by a Special Bench or by a higher court.

Facts: Reliance Industries Limited entered into a license agreement with M/s TIBCO Software Inc., 3165 Port, Palo Alto, California 94304, USA (“TIBCO”) in terms of which M/s TIBCO granted to the appellant and affiliates perpetual, non-exclusive, irrevocable, royalty-free, unlimited, non-transferable license in connection with the software maintained by M/s. TIBCO which allows internal operations including use of software as its backward infrastructure for ASP services and Web Hosting services Payments of license fees under the agreement were to be made gross of withholding taxes in India US$ 13,00,000/-. The AO held that the appellant was getting only license to use the software and no other title or interest in the software is being transferred to the appellant. The AO held that the software is an intellectual property and falls in the category of copyrights, patents, designs, trade-marks, formula, process, commercial/scientific knowledge and therefore consideration received for the license to use the software would constitute royalty. Accordingly, the AO held that the payment for purchase of software amounts to royalty within the meaning of section 9(1)(vi) of the I.T. Act and Article-12(3) of the DTAA.

This claim of the AO was rejected by the CIT (A) and it held that the appellant under the Software Contract acquired only a copy of software program and did not acquire any copyright over such software as envisaged by section-14 of the Copyright Act. Under these circumstances, payment made by the appellant to M/s TIBCO cannot be said to be payment for the use of or right to use of copyright. Thus, the said payment was made only for purchase of copyright article and does not amount to royalty within the meaning of Article-12(3) of the DTAA.

The Tribunal, while rejecting the claim of the AO and upholding the order of the CIT(A) observed at para 12:

“a) It is now established law that Computer software after being put on to a media and then sold, becomes goods like any other Audio Cassette or painting on canvas or a book and that the AO is wrong in holding that Computer software on a media, continues to be an intellectual property right and that the AO was wrong in treating this computer software as a “Patent” or as “Invention”. Thus the payment cannot be termed as “Royalty”.

b) That the definition of the term ‘Royalty’ in article 12(3) of the Indo-US DTAA is more restrictive than what is provided in section 9(1)(vii) of the Income-tax Act, 1961 and that in such a situation the provisions of the Double Taxation Avoidance Agreement override the domestic law.

c) That the assessee has purchased a copyrighted article and not the copyright itself. There is no transfer of any part of copyright.

d) As what is paid is not “royalty” under the Indo-US DTAA, and as it is covered under Article 7, which deals with “Business Profit” and as the foreign party does not have a Permanent Establishment in India, the same is not taxable in India and hence the assessee is not required to deduct tax at source from the said payment.”

The decision is available here.

Something for Christmas

Legal language can often be incomprehensible. However, it is our constant endeavour to simplify it for our readers. Yet, the festival of Christmas brings in such joy, that we found something that had to be shared with our readers.
Here is the link to the legal version of 'Twas night before Christmas.

Fall in Tax Collection in OECD Countries

Tax revenues fell in cash terms during 2009 in most OECD countries, driven downward by declining economic activity and tax cuts aimed at cushioning the effects of the recession that followed the financial crisis. Access the report here.

However, this was not reflected in the Indian tax collection scenario. Access the Economic Times coverage here.

CIT v. Tulsyan Nec Ltd. by Hon’ble Supreme Court of India

Date of Decision: 16th December, 2010

The question that arose before the Hon’ble Court was whether MAT credit admissible in terms of Section 115JAA has to be set off against the tax payable (assessed tax) before calculating interest under Sections 234B and 234C of the Income Tax Act, 1961?

Para 6: Thus, the tax credit allowable can be set off by the assessee while computing advance tax/ self-assessment tax payable for years 2 to 6 limited to the difference between the tax payable on the income computed under the normal provisions and tax payable on book profits in each of those years, as per assessee's own computation. Although the right to avail tax credit gets crystallized in year one, on payment of tax under Section 115JA and the set off thereof follows statutorily, the amount of credit available and the amount of set off to be actually allowed as in all cases of deductions/ allowances under Sections 30-37, is fluid/ inchoate and subject to final determination only on adjudication of assessment either under Section 143(1) or under Section 143(3). The fact that the amount of tax credit to be allowed or to be set off is not frozen and is ambulatory, does not take away/ destroy the right of the assessee to the amount of tax credit. (emphasis supplied)

Para 11: The position which emerged was that due to omission on one hand MAT credit was available for set off for five years under Section 115JAA but the same was not available for set off while calculating advance tax. This dichotomy was more spelt out because Section 115JAA did not provide for payment of interest on the MAT credit. To avoid this situation, Parliament amended Explanation 1 to Section 234B by Finance Act, 2006 w.e.f. 1.4.2007 to provide along with tax deducted or collected at source, MAT credit under Section115JAA also to be excluded while calculating assessed tax.

Para 13: It is immaterial that the relevant form prescribed under Income Tax Rules, at the relevant time (i.e. before 1.4.2007), provided for set off of MAT credit balance against the amount of tax plus interest i.e. after the computation of interest under Section 234B. This was directly contrary to a plain reading of Section 115JAA(4). Further, a form prescribed under the rules can never have any effect on the interpretation or operation of the parent statute.

The appeal of the department was dismissed.

The decision is available here.

King Prawns Ltd. v. ITO, ITA No.60/Mum/2010 by Hon’ble ITAT, Mumbai (AY 2004-05)

Date of Decision: 14^th December, 2010

The question to be considered in this appeal was inter-alia, whether the reduction of liability on account of term loan and other loans payable to a bank under one time settlement results into income to the assessee under section 28(i) or section 28(iv) or section 41(1) of the Income Tax Act, 1961.

For the interpretation of section 28(i), the Hon’ble Tribunal referred to the case of Mahindra & Mahindra v. CIT, (2003) 261 ITR 501 (Bom.) rendered by the Hon’ble Bombay High Court and concluded at para 10 that:

“The term loans received were definitely on capital account and related to capital assets. The waiver of such term loan does not constitute business and the waiver cannot be held as income u/s.28(i).”

Coming to the provisions of section 28(iv), the Hon’ble Tribunal referred to a coordinate bench judgment in Accelerated Freez & Drying Co. Ltd. Vs. DCIT, (2009) 31 SOT 442 (Cochin).

The Freez (supra) judgment noted at para 23 that:

“Section 28(iv) seeks to charge the value of any benefit or perquisite, whether convertible into money or not, arising from business or the exercise of a profession, as profits and gains of business or profession. Therefore, what is to be examined is whether the waiver of loan would amount to a perquisite so as to be taxable, as such, under section 28. The Bombay High Court in the case of Mahindra & Mahindra Ltd. Vs. CIT [2003] 261 ITR 501/128 Taxman 394, has explained that section 28(iv) seeks to charge the value of any benefit or perquisite, meaning thereby that the benefit must be in kind; the Court further held that waiver of loan is in respect of money transaction and, therefore, would not be in nature of any benefit or perquisite as construed in section 28(iv)” (emphasis supplied)

On account of section 41(1), the Freez (supra) judgment was again referred and applied. The relevant parts of Freez judgment are reproduced hereinbelow:

Para 30: “The Supreme Court in the case of Polyflex (India) (P.) Ltd. v. CIT [2002] 257 ITR 343/124 Taxman 374 has examined the constitution of section 41(1). The Court has pointed out that section 41(1) consists of two main ingredients: (a) loss or expenditure and (b) trading liability. The two ingredients of section 41(1) have to be read independently. As the first ingredient relates to loss or expenditure and the second ingredient relates to remission or cessation of trading liability, the Court has categorically ruled that the words `remission or cessation thereof’ shall apply only to a trading liability.”

Para 31: “There was no doubt that the term loans availed by the assessee from three banks were not in nature of trading liability but were in nature of capital liability. Therefore, waiver of loan liability was not waiver of any trading liability. The waiver of capital liability would not become income under section 41(1) on the ground of remission or cessation thereof.”

Since in the given case, the remission was also of a capital liability, the same was not held to be a revenue receipt.

The judgment conclusively noted on this issue at para 14:

Para 14: “In view of the above discussion, we hold that the reduction of the liability on account of term loan and other loans payable to the bank under one time settlement scheme, does not result into income to the assessee either u/s.28(i) or u/s.28(iv) or u/s.41(1) of the Income-tax Act, 1961. Accordingly, ground nos.1 to 3 of the assessee’s appeal, are allowed.”

The discussion pertaining to addition of certain amounts being disallowance of business expenditure has not been discussed in this post.

The judgment is available here.