No royalty income on payment for transfer of software which is a ‘copyrighted article’ and not a ‘copyright right’
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No royalty income on payment for transfer of software which is a ‘copyrighted article’ and not a ‘copyright right’

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The Delhi High Court (High Court) in the case of Infrasoft Ltd. dealt with issue of taxability of consideration for grant of licences for the use of software. The High Court held that in the present ...

The Delhi High Court (High Court) in the case of Infrasoft Ltd. dealt with issue of taxability of consideration for grant of licences for the use of software. The High Court held that in the present case what was transferred was neither the copyright in the software nor the use of the copyright in the software, but the right to use the copyrighted material or article which was clearly distinct from the rights in a copyright. Accordingly, the High Court held that the consideration received for the transfer of licences for the use of software does not amount to royalty under the India-USA tax treaty.

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    No royalty income on payment for transfer of software which is a ‘copyrighted article’ and not a ‘copyright right’ No royalty income on payment for transfer of software which is a ‘copyrighted article’ and not a ‘copyright right’ Document Transcript

    • KPMG FLASH NEWS KPMG IN INDIA No royalty income on payment for transfer of software which is a ‘copyrighted article’ and not a ‘copyright right’ 28 November 2013 Executive summary Recently, the Delhi High Court (High Court) in the case of 1 Infrasoft Ltd. (the taxpayer) dealt with issue of taxability of consideration for grant of licences for the use of software. The High Court held that in the present case what was transferred was neither the copyright in the software nor the use of the copyright in the software, but the right to use the copyrighted material or article which was clearly distinct from the rights in a copyright. Accordingly, the High Court held that the consideration received for the transfer of licences for the use of software does not amount to royalty under the India-USA tax treaty (tax treaty). Facts of the case The taxpayer is an international software marketing and development company. It is engaged in the business of developing and manufacturing civil engineering software. The taxpayer had opened a branch office in India. The branch in India imports the package in the form of floppy _________________ 1 DIT v. Infrasoft Ltd. (ITA No. 1034/2009) – Taxsutra.com disks or CDs depending on the requirements of their customers. The system was then delivered to a client/customer. The delivery of the system entails installation of the system on the computers of the customers and training of the customers for operation of the system. The branch office further undertakes the responsibility of updation and operational training apart from providing support for solving any software issues. During the year under consideration the customised softwares were licensed to the Indian customers and the branch office of the taxpayer in India performed services involving interface to peripheral installation and training. The Assessing Officer (AO) taxed the receipts on grant of licence for the use of software as ‘royalty’ as per Article 12 of the tax treaty. Further Commissioner of Income-tax (Appeal) [CIT(A)] held that the amount received by the taxpayer from its Indian customers under software licence agreement was in the nature of royalty and same was chargeable to tax in India as per Explanation 2 to Section 9(1)(vi) of the Act read with Article 12 of the tax treaty. © 2013 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
    • On the other hand, the Delhi Bench of Income-tax Tribunal (the Tribunal) relying on the decisions in the cases of 2 3 Motorola Inc. and Samsung Electronics Co. Ltd. held that the amount received by the taxpayer under the licence agreement for allowing the use of the software was not royalty either under the Act or under the tax treaty. Aggrieved by this order the tax department filed an appeal before the High Court. The High Court Ruling The High Court observed that as per the Licensing Agreement the licence was non-exclusive, non-transferable and the software has to be used in accordance with the agreement. Only one copy of the software was being supplied for each site. The licensee was permitted to make only one copy of the software and associated support information and that also for backup purposes. It was also stipulated that the copy so made shall include Infrasoft’s copyright and other proprietary notices. All copies of the Software were the exclusive property of Infrasoft. It was observed that a non-exclusive and non-transferable licence enabling the use of a copyrighted product cannot be construed as an authority to enjoy any or all of the enumerated rights ingrained in Article 12 of the tax treaty. Where the purpose of the licence or the transaction was only to restrict use of the copyrighted product for internal business purpose, it would not be legally correct to state that the copyright itself or right to use copyright has been transferred to any extent. Distinction has to be made between the acquisition of a ‘copyright right’ and a ‘copyrighted article’. Copyright is distinct from the material object, copyrighted. Copyright is an intangible incorporeal right in the nature of a privilege, quite independent of any material substance, such as a manuscript. Copyright or even right to use copyright is distinguishable from sale consideration paid for ‘copyrighted’ article. This sale consideration is for purchase of goods and is not royalty. The High Court observed that Supreme Court in the case of 4 Tata Consultancy held that software may be intellectual property and contained on a medium was a marketable commodity and an object of trade and commerce. 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 sales tax. _______________ Further 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 ‘goods’. There is no difference 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. The High Court distinguished the Karnataka High Court decision in the case of Samsung Electronics Co. 5 Ltd and held that the licence granted to the licensee permitting him to download the computer programme and storing it in the computer for his own use was only incidental to the facility extended to the licensee to make use of the copyrighted product for his internal business purpose. The said process was necessary to make the programme functional and to have access to it and is qualitatively different from the right contemplated by the said provision because it is only integral to the use of copyrighted product. In view of above, the High court held that there was no transfer of any right in respect of copyright by the taxpayer and it was a case of mere transfer of a copyrighted article. The payment is for a copyrighted article and represents the purchase price of an article and cannot be considered as royalty. The High Court has not examined the effect of the retrospective amendment to Section 9 (1)(vi) of the Act and also whether the amount received for use of software would be royalty in terms thereof as the taxpayer was covered by the tax treaty, the provisions of which were more beneficial. Our comments The controversy surrounding characterisation and taxation of computer software payments have been a subject matter of debate before the courts from a long time. Ideally, if the transaction is one granting rights in a copyright, it would generally be in the nature of ‘royalties’. As opposed to that income from a transaction relating to provision of services would be fees for technical services/business profits while a sale of product (not being a sale of copyright itself) would give rise to business profits. _______________ 2 Motorola Inc., Ericson Radio System AB And Nokia Networks OY v. DCIT [2005] 147 Taxman 39 (Del) 3 Samsung Electronic Companies Ltd. v. ITO [2005] 276 ITR 1 (Bang) 4 Tata Consultancy Services v. State of Andhra Pradesh [2004] 271 ITR 401 (SC) 5 CIT v. Samsung Electronics Co. Ltd. [2012] 345 ITR 494 (Kar) © 2013 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
    • On one hand the argument is that in purchasing software, end-users merely receive a copy of the software, that is to say, a copyrighted article and not a right in a copyright in the software. The payments made represent purchase price for the article and are in the nature of business income. Consequently, such payments are not liable to tax in India in the absence of a permanent establishment in India. On the other hand the tax department has been arguing that such purchases are in effect a licence granted by software companies to end-users, and payments made for the same represents royalty income. The Finance Act, 2012 keeping in perspective of conflicting decisions on the subject matter and with a view to restating the legislative intent, amended Section 6 9(1)(vi) of the Act with retrospective effect from 1 June 1976 to include consideration for use or right to use of computer software under the ambit of royalty. However, the High Court in this case has not dealt with the impact of this amendment. While initially decisions were rendered in favour of taxpayers, in the recent past the courts have also 7 delivered certain decisions in favour of the tax department based on facts of each specific case. This trend continued with the Authority for Advance Rulings as well as the Karnataka High Court which confirmed the Microsoft Corporation’s decision wherein it was held that payments made by end users were for granting of licence in copyright and other intellectual property rights in product, therefore said payment would amount to royalty. However, in this decision, the Delhi High Court has held that there is no royalty income if the payment is for a transfer of software which is a ‘copyrighted article’ and not a ‘copyright right’. As per news reports, the Supreme Court has admitted a Special Leave Petition in the cases of IBM and Sonata, where the payments for shrink-wrapped (standardized) software were held as royalty. The Supreme Court's decision on this issue will resolve the controversy with respect to taxability of such software payments. ______________ 6 Explanation 4 to Section 9(1)(vi)—For the removal of doubts, it is hereby clarified that the transfer of all or any rights in respect of any right, property or information includes and has always included transfer of all or any right for use or right to use a computer software (including granting of a licence) irrespective of the medium through which such right is transferred. 7 Microsoft Corporation v ADIT [2010] 134 TTJ 257 (Del) © 2013 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
    • www.kpmg.com/in Ahmedabad Safal Profitaire B4 3rd Floor, Corporate Road, Opp. Auda Garden, Prahlad Nagar Ahmedabad – 380 015 Tel: +91 79 4040 2200 Fax: +91 79 4040 2244 Hyderabad 8-2-618/2 Reliance Humsafar, 4th Floor Road No.11, Banjara Hills Hyderabad 500 034 Tel: +91 40 3046 5000 Fax: +91 40 3046 5299 Bangalore Maruthi Info-Tech Centre 11-12/1, Inner Ring Road Koramangala, Bangalore 560 071 Tel: +91 80 3980 6000 Fax: +91 80 3980 6999 Kochi 4/F, Palal Towers M. G. Road, Ravipuram, Kochi 682 016 Tel: +91 484 302 7000 Fax: +91 484 302 7001 Chandigarh SCO 22-23 (Ist Floor) Sector 8C, Madhya Marg Chandigarh 160 009 Tel: +91 172 393 5777/781 Fax: +91 172 393 5780 Chennai No.10, Mahatma Gandhi Road Nungambakkam Chennai 600 034 Tel: +91 44 3914 5000 Fax: +91 44 3914 5999 Delhi Building No.10, 8th Floor DLF Cyber City, Phase II Gurgaon, Haryana 122 002 Tel: +91 124 307 4000 Fax: +91 124 254 9101 Kolkata Infinity Benchmark, Plot No. G-1 10th Floor, Block – EP & GP, Sector V Salt Lake City, Kolkata 700 091 Tel: +91 33 44034000 Fax: +91 33 44034199 Mumbai Lodha Excelus, Apollo Mills N. M. Joshi Marg Mahalaxmi, Mumbai 400 011 Tel: +91 22 3989 6000 Fax: +91 22 3983 6000 Pune 703, Godrej Castlemaine Bund Garden Pune 411 001 Tel: +91 20 3050 4000 Fax: +91 20 3050 4010 The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation. © 2013 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. The KPMG name, logo and “cutting through complexity“ are registered trademarks of KPMG International Cooperative (“KPMG International”), a Swiss entity. © 2013 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.