In this article we will consider whether the amounts received on account of supply of off the shelf software can be taxed as ‘royalty’ under Section 9(l)(vi) of the Act and Article 12 of the Double Taxation Avoidance Agreement between India and Ireland (‘India- Ireland Tax Treaty).
One view point is that the amounts receivable for supply of ‘off the shelf’ software are for grant of ‘copyright’ and accordingly, the receipts are in the nature of ‘Royalty’ as per amended Section 9(1)(vi) of the Act and Article 12 of the India-Ireland Tax Treaty.
This view is supported by the judgement of the Hon’ble Karnataka High Court in the case of Samsung Electronics Co. Ltd [345 ITR 494] and the decision of the Mumbai Bench in the case of DDIT v. Reliance Infocomm Ltd in which it was held that such payment is for the use of or right to use of copyright and is royalty within the meaning of Article 12 of India Ireland DTAA.
shrink wrapped/off the shelf software
Software is regarded as shrink wrapped/off the shelf software if the products provided are standard products already developed and made available to other customers. The user only acquires a license to use a copy of the software for its business purpose. The right to make multiple copies of the software is limited only for the purpose of the user’s own operations. It is not permitted to resell the software products and components or commercially exploit the same. The license is essentially granted for the user’s own use and it has not been granted any rights in the underlying copyright.
The owner exclusively owns all the Intellectual Property Rights (IPR) in and to the software. It merely grants to the user a ‘copyrighted article’ and not the ‘copyright in the article’. Hence, the user does not use or have any right to use the copyright in the software products. Therefore, what is given to the user by the owner is copyrighted article and not copyright in the copyrighted article and hence, the same is not chargeable to as per Article 12 of the India Ireland Tax Treaty.
Copyright vs Copyrighted Article
Normally, the owner grants a perpetual, non-exclusive, irrevocable, royalty-free, non-assignable and non- transferable license to the user to use the software in object code form. Further, all software and media on which the software is delivered remain the sole and exclusive property and trade secret of the owner / its licensors.
As per Scope of permitted use, the user has no right to modify, adopt, translate, reverse engineer, decompile, disassemble, or create derivate works based on the software. It can use the software only for internal training purposes and to process its own data and that of its affiliates. Further, the user cannot use the software to offer time sharing, service bureau or other computer based services to third parties. The software can be used only on specified equipment and location as agreed between the parties. The software can be used only within a single operating environment. The user will only make copies of the software for specified purposes (such as primary copy for production, training, testing, etc) as mentioned and for back-up and archival purposes.
The payments received by the owner is not for the use of or the right to use any patent, trademark, design or model, plan, secret formula or process or information concerning industrial, commercial or scientific experience., but for use of a ‘copyrighted article’ which emanates from use of the ‘copyright’.
Definition of ‘royalty’ in Article 12 of DTAA
Paragraph 3(a) of Article 12 (which defines the term ‘Royalty’ for the purpose of India Ireland Tax Treaty) does not include supply of a ‘copyrighted article’ and only such payments, which have been made for the use of, or the right to use the copyright in the literary, artistic or scientific work will qualify as ‘royalty’ under the India Ireland Tax Treaty.
Article 12 of India Ireland Tax Treaty reads as follows:
“3. (a) The term “royalties” as used in this Article means payments of any kind received as a consideration for the use of, al* the right to use, any copyright of literary, artistic or scientific work including cinematograph films or films or tapes for radio or television broadcasting, any patent, trade mark, design or model, plan, secret formula or process or for the use of or the right to use industrial, commercial or scientific equipment, other than an aircraft, or for information concerning industrial. commercial or scientific experience”
Only in a situation where the payments are for the use of ‘copyright’ in copyrighted article, the said receipts can be treated as “royalty”. Payments received for the sale of a copyrighted article and not for the use of the copyright in the said copyrighted article is not covered if it is evident from the nature of software and the terms of the software licence agreement, the user has not made any payments for use of a copyright or right to use a copyright in the software. The owner has only supplied copyrighted software to Reliance and not any rights in the said software. Accordingly, receipts from the user are not taxable as ‘Royalty’ in the hands of Assessee under Article 12 of India- Ireland Tax Treaty.
Case laws on taxability of software payments as royalty
(i) The Hon’ble Supreme Court in the case of Tata Consultancy Services Pvt. Ltd. Vs. State of Andhra Pradesh (2004) 271 ITR 401 has held as follows: –
“A software programme may consist of various commands which enable the computer to perform a designated task. The copyright in that programme may remain with the originator of the programme. But the moment copies are made and marketed, it becomes goods, which are susceptible to sale tax. Even intellectual property, once it is put on to a media, whether it be in the form of books or canvas (In case of painting) or computer discs or cassettes, and marketed would become ‘good’. We see no different between a sale of a software programme on a CD/floppy disc from a sale of music on a cassette/CD or a sale of a film on a video cassette/CD. In all such cases, the intellectual property has been incorporated on a media for purposes of transfer. Sale is not just of the media which by itself has very little value. The software and the media cannot be split up. What the buyer purchases and pays for is not the disc or the CD. As in the case of paintings or books or music or films the buyer is purchasing the intellectual property and not the media i.e. the paper or cassette or disc or CD. Thus, a transaction of sale of computer software is clearly a sale of goods within the meaning of the term as defined in the said Act.”
Thus computer software when it is put on to a media and sold has become goods like any other audio cassette or painting on canvas or a book. It is ceases to be transfer of intellectual property right.
(ii) Bangalore Bench of the Tribunal in the case of Lucent Technologies Hindustan Ltd. Vs. ITO, 92 ITD 366 (Bang) has also taken the view that in such a situation there is no acquisition of any right in software. Definition of ‘royalty’ is given in section (9)(1) Explanation (2) of the Act and the definition of Royalty in Article 12(3) of the Indo-US DTAA shows that definition of royalty under DTAA is more restrictive than what is provided in section (9)(1) of the Act. Under the definition as contained in DTAA, there should be a transfer of copyright. Sale of software by the assessee to the end user does not involve any transfer of copyright either in part or in whole; therefore consideration paid by the distributor cannot be said to be a payment for right of use copyright or transfer of use of copyright. It has been uniformly held in several decisions of the ITAT that sale of shrink-wrap software does not involve receipt of consideration, which can be said to be royalty.
Decisions in this regard are as follows :-
• Samsung Electronics Co. Ltd. Vs. ITO, 93 TTJ 658
• Motorola Incorporation, 270 ITR (AT) 62
• Sonata Information Technologies Ltd., ITA No. 1561 to 1580/Bang/2004 dated 31.1.2006.
(iii) Computer programme cannot also be treated as patent and invention. Computer programme cannot said to be an invention and therefore cannot be said to be covered by the Patient Act. Computer software cannot also be treated as process. End user of the software in the case of shrink-wrap software does not have any access to source code. He has only right to use the software for his personal or business use.
(iv) In Capgemini Business Services (India) Ltd (supra) after considering all the decision available on the issue including Samsung Electronics Company Ltd. & Others (supra), Verizon Communication Singapore (supra), Reliance lnfocom Ltd. (supra) and Viacomm 18 Media (supra) held that where the payment is made for the copyrighted article the same cannot be considered as payment for the transfer of the copyright and cannot be taxed as royalty by observing as under:-
“49. The provisions of the Copyright Act, as discussed above are clear and unambiguous in this respect. If the assessee has purchased a copy of a computer software programme and he uses the said copy for his business purpose and if the said use falls within the scope and purview of the exceptions of section 52, such as the use of it for the purpose for which it is supplied and to make backup copies for temporary purpose as a protection against loss or damage and doing of any act necessary to obtain information essential for operating the software for the purpose for which it is purchased etc. as provided under section 52, then in that event it cannot be said to be an infringement of copyrights of the author or owner of the work. As held by the Hon’ble Karnataka High Court in the case of “Samsung Electronics Company Ltd. & Others” (supra) while relying upon Article 3 sub section (2) of the DTAA with US as the identically worded article being there in almost all the tax treaties with other countries, that any term not defined in the convention shall, unless the context otherwise requires, have the meaning which it is under the laws of that ‘State’ concerning the tax to which the convention applies. In view of above, when we see the definition as per the statutory provisions/domestic law of the country i.e. Copyright Act, 1957 of India which is the taxing State in this case, it is apparent that the fair use of the work for the purpose of which it is being purchased and doing of such other acts including making of copy for protection from damage or loss cannot, in any case, said to be any infringement of copyright whether or not any license in this respect has been granted by the author/owner of the work. The right to use or for use of the product accrues to the purchaser by the operation of the statute and as held by the Hon’ble Delhi High Court in the case of “Infrasoft Ltd.” (supra), the same would amount to the sale of a goods and the acts done such as downloading of the same to the computer or making backup copies etc. would be the necessary acts for enabling the use of the product and would not amount to the transfer of copyright or right therein, but only the transfer of the copyrighted product and thus will not be covered under the definition of royalty under DTAA. The consideration, thus, paid will be the business income of the non-resident and taxable in accordance with the provisions of DTAA. We may clarify here that even in cases where the owner of the copyrighted work may restrict the use of or right to use the work by way of certain terms of the license/software agreement, the validity or the enforceability of the same may be subject matter in other laws such as Indian Contract Act 1872, Sale of goods Act 1930 or the Consumer Protection Act 1986 etc., but, the same in any way cannot be said to grant of or infringement of copyright in the light of specific statutory provisions of Copyright Act 1957.
52. Even otherwise, the Revenue has not cited any direct case law of the jurisdictional High Court of Bombay before us. In the case laws cited by the Revenue of the Hon’ble Karnataka High Court in the matter of “CIT vs. Samsung Electronics Company Ltd.” (supra) and “ClT vs. Synopsis International Old Ltd.” (supra) though a view in favour of the Revenue has been taken, but, the Hon’ble Delhi High Court in the case of “D1T vs. Infrasoft Ltd.” (supra) which is a latter decision and has discussed the Samsung case also has taken the view in favour of the assessee. The Hon’ble Delhi High court has taken the identical view favoring the assessee in the case of “D1T vs Nokia Network” (supra) and in the case of “DIT vs. Ericson A.B.” (supra) also. The Hon’ble Bombay High gaud in the case of “The Addl. Commissioner of Sales Tax vs. M/s Ankit international,” Sales Tax Appeal No.9 of 2011 vide order dated 15 September, 2011 while relying upon the decisions of the Hon’ble Supreme Court in “The Commissioner of Income Tax V. Vegetable Product Ltd.” (1973) 88 ITR 192 and in “Mauri Yeast India Pvt. Ltd. V. State of UP.” (2008) 14 VST 259(SC) (2008) 5 S.C. C. 680 has held that, if two views in regard to the interpretation of a provision are possible, the Court would be justified in adopting that construction which favours the assessee. Reliance can also be placed in this regard on the decision of Hon’ble Supreme Court in “Bihar State Electricity Board and another vs. M/s. Usha Martin Industries and another: (1997) 5 SCC 289. We accordingly adopt the construction in favour of the assessee. In view of our discussion made above, this issue is accordingly decided in favour of the assessee.”
(v) In Galatea Limited v. DCIT it was held that payment for the copyrighted article will not be taxed as “Royalty” as defined under the Article 12(3) of India-Israel tax treaty. The Bench observed as under: –
“35. Thus, the status of the provisions in the treaty is kept same as was in the pre- amended law as contained in the provisions of the Act. According to these provisions of the treaty, as has been explained in various judgments, transfer of copyright is different from transfer of copyrighted article. Thus, in view of the facts before us, even if the payment for software is taxed separately from hardware, on a standalone basis, even then the same would not fall within the scope of Article 12(3) since there was merely transfer of a copyrighted article, and not the copyright or any rights contained therein.”)
(vi) The Hon’ble Delhi High Court in the case of Nokia Networks OY (supra) held that the payment for copyrighted article does not fall within the purview of ‘Royalty’ under the DTAA. The Hon’ble Delhi High Court observed as under: –
“59. Be as it may, in order to qualify as royalty payment, within the meaning of Section 9(1)(vi) and particularly clause (v) of Explanation-II thereto, it is necessary to establish that there is transfer of all or any rights (including the granting of any license) in respect of copy right of a literary, artistic or scientific work. Section 2(o) of the Copyright Act makes it clear that a computer programme is to be regarded as ‘literally work’. Thus, in order to treat the consideration paid by the cellular operator as royalty, it is to be established that the cellular operator, by making such payment, obtains all or any of the copyright rights of such literary work. In the present case, this has not been established. It is not even the case of the Revenue that any right contemplated under Section 14 of the Copyright Act, 1957 stood vested in this cellular operator as a consequence of Article 20 of the Supply Contract. Distinction has to be made between the acquisition of a ‘copyright right” and a “copyrighted article.
60…….We also find force in the submission of Mr. Dastur that even assuming that the payment made by the cellular operator is regarded as payment made by way of royalty as defined in Explanation 2 below Section 9(1)(vi), nevertheless, it can never be regarded as royalty within the meaning of the said term in article 13, para 3 of the DTAA. This is so because the definition in the DTAA is narrower that the definition in the Act. Article 13(3) brings within the ambit of the definition of royalty a payment made for the use of or the right to use a copyright of a literary work. Therefore, what is contemplated is a payment that is dependent upon user of the copyright and not a Lumpsum payment as is the position in this case.”
(vi) The Hon’ble Delhi High Court in the case of Ericsson Radio Systems AB (supra) observed as under: –
“Be as it may, in order to qualify as royalty payment, within the meaning of Section 9(1) (vi) and particularly clause (v) of Explanation-11 thereto, it is necessary to establish that there is transfer of all or any rights (including the granting of any license) in respect of copy right of a literary, artistic or scientific work. Section 2(o) of the Copyright Act makes it clear that a computer programme is to be regarded as a ‘literary work’. Thus, in order to treat the consideration paid by the cellular operator as royalty, it is to be established that the cellular operator, by making such payment, obtains all or any of the copyright rights of such literary work. In the presence case, this has not been established, it is not even the case of the Revenue that any right contemplated under Section 14 of the Copyright Act, 1957 stood vested in this cellular operator as a consequence of Article 20 of the Supply Contract. Distinction has to be made between the acquisition of a “copyright right” and a “copyrighted article”.
(vii) The Mumbai Bench in the case of DDIT v. Solidworks Corporation (supra) following the decision of Hon’ble Delhi High Court in the case of Ericsson AB held that the receipts from supply of software are not taxable as Royalty’
(viii) The Hon’ble Delhi High Court in the case of New Skies Satellite BV & Ors. (supra) held as under: –
“59. On a final note, India’s change in position to the OECD Commentary cannot be a fact that influences the interpretation of the words defining royalty as they stand today The only manner in which such change in position can be relevant is if such change is incorporated into the agreement itself and not otherwise. A change in executive position cannot bring about a unilateral legislative amendment into a treaty concluded between two sovereign states. It is fallacious to assume that any change made to domestic law to rectify a situation of mistaken interpretation can spontaneously further their case in an international treaty. Therefore, mere amendment to Section 9(1)(vi) cannot result in a change. It is imperative that such amendment is brought about in the agreement as well. Any attempt short of this, even if it is evidence of the state’s discomfort a letting data broadcast revenues slip by, will be insufficient to persuade this Court to hold that such amendments are applicable to the DTAAs.
60. Consequently, since we have held that the Finance Act, 2012 will not affect Article 12 of the DTAAs, it would follow that the first determinative interpretation given to word “royalty” in Asia Sate/Ills, when the definitions were in fact pari materia (in the absence of any contouring explanations), will continue to hold the field for the purpose of assessment years preceding the Finance Act, 2012 and in all cases which involve a Double Tax Avoidance Agreement, unless the said DTAAs are amended jointly by both parties to incorporate income from data transmission services as partaking of the nature of royalty, or amend the definition in a manner so that such income automatically becomes royalty. It is reiterated that the Court has not returned a finding on whether the amendment is in fact retrospective and applicable to cases preceding the Finance Act of 2012 where there exists no Double Tax Avoidance Agreement.”
Other judgements on taxability of supply of off the shelf/ shrink wrapped software
– Patspin India Ltd vs DCIT [129 ITD 35]
– Delhi High Court in case of Halliburton Export Inc. (ITA No. 3631 of 2016) which approved the Delhi Tribunal’s decision in its own case (152 ITD 803)
– DIT vs Infrasoft Limited [220 Taxman 273].
– Capgemini Business Services (India) Ltd [TS-100-ITAT-2016 (Mum)]
– Samsung Electronics Company Ltd. & Others [345 ITR 494],
Verizon Communication Singapore [361 ITR 575],
Reliance lnfocom Ltd. [37 CCH 0069],
Viacomm 18 Media Pvt. Ltd. [44 taxman.com 1]
Galatea Limited v. DCIT [46 ITR (Trib.) 690]
DIT v. Nokia Networks OY (212 Taxman 68)
Ericsson Radio Systems AB (343 ITR 470)
DDIT vs Solidworks Corporation [17 ITR (Trib) 510]
Section 90(2) of the Income-tax Act, 1961
As per the provisions of Section 90(2) of the Act, a non-resident assessee is eligible to be governed under the provisions of the Act or the Tax Treaty, whichever is more beneficial. Revenues for grant of software are not in the nature of ‘Royalty’ but in the nature of ‘Business Profits’ and since, the owner does not have Permanent Establishment (‘PE’) in India within the meaning of Article 5 of India Ireland Tax Treaty, the said receipts are not taxable as ‘Business Profits’ in India.
The Hon’ble Delhi High Court, recently in the decision of New Skies Satellite BV & Ors. (382 ITR 114) has also held that the unilateral amendment made by the Parliament of a one state will not automatically amend the DTAA’s signed by that state with the other states.
Therefore, assuming without admitting that the revenues from supply of software are chargeable to tax in India under the Act, the Hon’ble High court has held that a unilateral amendment of the definition of “Royalty” in the Act would not automatically amend the definition of “Royalty’ in the DTAA. Accordingly, the said revenues would not be taxable as ‘Royalty” in India by virtue of Article 12 of the India Ireland Tax Treaty.
In WNS North America [152 TTJ 145] has held that despite the retrospective amendment to the Act, the amendment will not apply to the treaty per se. It was further observed that if there is some provision in the treaty which is contrary to the provision of the domestic law, then it is the contrary provision of the treaty which shall override the provision in the domestic law in the computation of income as per the treaty. Further, the Hon’ble ITAT held that since the explanation inserted vide retrospective amendment to the Act, making the definition of ‘royalty’ inclusive in nature, was not a part of ‘royalty’ definition under the relevant DTAA, such retrospective amendment should not be read in the DTAA also.
The Mumbai ITAT decision in case of B4U International Holdings Limited (‘B4U’) [181 ITR (Trib.) 62] has held that despite the amendment to the Act (vide the Finance Act 2012), such payment would not be taxable as ‘royalty’ since there was no change in the treaty between India and USA (in this case payer was USA company).
The Mumbai ITAT decision in case of Baan Global BV (ITA No. 7048/M/2010) has held that one contracting state which is a party to a treaty cannot unilaterally alter its provision and enlarge the scope of any term from the prism of its domestic law. If there is no amendment in the treaty and if any amendment is carried out under the domestic law then same cannot be read into the treaty.
More judgements holding that in the case of shrink wrapped/ off the shelf, Software does not amount to Royalty
(i) Galatea Limited [46 ITR 690] Mumbai Tribunal.
(ii) Capegemini Business Services (India) Ltd [46 CCH 253] Mumbai Tribunal.
(iii) Datamine International Limited [46 CCH 296] Delhi Tribunal.
(iv) Solid Works Corporation [ITA.No. 8721/M/2010] Mumbai Tribunal.
(v) Reliance Industries Ltd & Ors [47 CCH 94 (Mum)]
(vi) Baan global BV [ITA.No.7048/M/2010] Mumbai Tribunal.
(vii) Galatea Limited [47 CCH 325] Mumbai Tribunal.
(viii) Halliburton Export Inc [152 ITD 803 (Del Tribunal) Dated 14 February 2014 approved by (ITA.No. 363/ 2016) Delhi (High Court)]
(ix) Qad Europe B.V. [ITA.Nos. 83 & 84/Mum/2007] Mumbai Tribunal
(x) First Advantage Private Limited [ITA.No. 3031/Mum/2010 & ITA.No. no.
3032/Mum/2010] Mumbai Tribunal
(xi) Dassault Systemes, Mumbai Tribunal [79 taxmann.com 205]
(xii) National Stock Exchange of India, Mumbai Tribunal [ITA.No.
(xiii) Mckinsey Knowledgement Centre India Private Limited, New Delhi Tribunal [ITA.No. 407/Del/2013].
in order to qualify as royalty payment, within the meaning of Section 9(1) (vi) and particularly clause (v) of Explanation-11 thereto, it is necessary to establish that there is transfer of all or any rights (including the granting of any license) in respect of copy right of a literary, artistic or scientific work. Section 2(o) of the Copyright Act makes it clear that a computer programme is to be regarded as a ‘literary work’. Thus, in order to treat the consideration paid by the cellular operator as royalty, it is to be established that the cellular operator, by making such payment, obtains all or any of the copyright rights of such literary work. In the presence case, this has not been established, it is not even the case of the Revenue that any right contemplated under Section 14 of the Copyright Act, 1957 stood vested in this cellular operator as a consequence of Article 20 of the Supply Contract. Distinction has to be made between the acquisition of a “copyright right” and a “copyrighted article”.