License granted for making use of shrink wrapped software is taxable as royalty

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Recently, the Mumbai Bench of the Income-tax Appellate Tribunal (the Tribunal) in the case of Reliance Infocom Ltd. held that payment made for ‘shrink wrapped’ or ‘off the shelf’ software is taxable as royalty under the Income-tax Act, 1961 (the Act) as well as various tax treaties.
The Tribunal held that license granted for making use of the copyright in respect of the said shrink wrapped software amounts to transfer of right to use the copyright. Further, the non-resident supplier has not been supplying software as a part of equipment purchased but as a stand-alone software under an ‘End User License Agreement’.

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License granted for making use of shrink wrapped software is taxable as royalty

  1. 1. © 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. KPMG FLASH NEWS KPMG IN INDIA License granted for making use of shrink wrapped software is taxable as royalty 9 October 2013 Background Recently, the Mumbai Bench of the Income-tax Appellate Tribunal (the Tribunal) in the case of Reliance Infocom Ltd. 1 (the taxpayer) held that payment made for ‘shrink wrapped’ or ‘off the shelf’ software is taxable as royalty under the Income-tax Act, 1961 (the Act) as well as various tax treaties 2 . The Tribunal held that license granted for making use of the copyright in respect of the said shrink wrapped software amounts to transfer of right to use the copyright. Further, the non-resident supplier has not been supplying software as a part of equipment purchased but as a stand-alone software under an ‘End User License Agreement’ (EULA). _______________ 1 DDIT v. Reliance Infocom Ltd (ITA No. 837/M/07………..5075/M/08), DDIT v. Reliance Communications Infrastructure Ltd (ITA No. 5468/M/08), DDIT v. Reliance Infostream Private Limited (ITA No.730/Mum/09), DDIT v. Reliance Telecom Ltd (ITA No 5093/M/08), ADIT v. Lucent Technologies GRL LLC (ITA No. 7001/M/10) – Taxsutra.com 2 USA, UK, Australia, China, Canada, Sweden, etc Facts of the case  The taxpayer, an Indian company, entered into a Wireless Software Contract, for purchase of certain software for the purposes of operation of wireless telecommunication network in India, with Lucent Technologies Hindustan Pvt. Ltd. (LTHPL), an Indian company of Lucent Group, USA.  Subsequently the taxpayer also entered into a Wireless Software Assignment and Assumption Agreement with LTHPL and Lucent Technologies GRL LLC (LTGL) USA towards supply of software required for telecom network. Similarly, the taxpayer also entered into a software supply contract with other foreign companies.  LTGL was also responsible to provide service for correcting the defective software and providing software and updates without any additional consideration.
  2. 2. © 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 decision of the Special Bench in the case of Motorola 6 does not apply as the software in the present case was not supplied along with hardware, by separate purchase orders from different companies, so the facts of the case were different. Taxpayer’s contentions  The main purpose of entering into various contracts was for setting up mobile network and to place order for hardware and software since software does not work without the hardware network. The software was specific to the machinery on which it works and was different from shrink wrapped software which was sold off the self.  Referring to Kanga & Palkiwala commentary it was contended that the publisher may have copyrights of authors but the ultimate user by purchasing the book gets only a copyrighted article and no copyrights.  Since the software was in binary system, the word license was used but this was different from License of copyright contemplated under the Act. The license was only for exclusive use by the taxpayer and no intellectual property rights were transferred nor were any copyrights given.  The amended provisions of the Act are not applicable to the present case since tax treaty has not been amended. The taxpayer relied on various decisions 7 .  The sale and supply was from outside India, only goods were supplied on fixed price basis and there was no separate license fee. This software was specified for running the equipment (equipment specific) and hence was part of supply of the network agreement. Tribunal’s ruling  In the case of Ericson AB 8 and Nokia Networks AY 9 , the software was supplied along with hardware as part of equipment and there was no separate sale of software. Software was integral part of supply of equipment for telecommunications in those cases. However, in the instant case, software was supplied separately and not along with the equipments. ________________ 6 Motorola Inc. v. DCIT [2005] 95 ITD 269 (Del) (SB) 7 B4U Int.holdings ltd v. DCIT [2012] 18 ITR(T) 62 (Mum), WNS North America Inc v. ADIT [2013] 25 ITR(T) 582 (Mum) 8 DIT v. Erickson AB [2012] 204 Taxmann 192 (Del) 9 DIT v. Nokia Networks OY [2013] 212 Taxman 68 (Del)  During the year under consideration, the taxpayer made application under Section 195(2) of the Act before the Assessing Officer (AO) for seeking nil withholding tax order on payments for purchase of the software.  The AO held that the taxpayer was getting only license to use the software and it was in the nature of royalty taxable under the Act and tax treaty. Therefore, withholding of tax was required on payment to foreign supplier. Subsequently, after deducting tax as directed by the AO, the taxpayer preferred appeals before the Commissioner of Income-tax (Appeals) [CIT(A)].  The CIT(A) observed that the taxpayer was forbidden to decompile, reverse engineer, disassemble, decode, modify or sub-license the software, as per the agreements. Accordingly, CIT(A) held that the amounts paid cannot be considered as royalty as the taxpayer purchased ‘goods’ which was a copyrighted article and it was not taxable. Issue before the Tribunal  Whether payment made for the license granted for making use of the copyright in respect of the shrink wrapped software amounts to royalty? Tax department’s contentions  The taxpayer had obtained only a license to use copyright under the Copyright Act. Further, such software would also fall within the definition of royalty under the Act.  Relying on the decisions of the Delhi High Court in the case of Autodisk Inc. 3 and Microsoft Computer 4 it was contended that there is copyright involved since the infringement is punishable under the law. The tax department also relied on the stand of India on OECD commentary and various decisions 5 .  The payment was not for copyrighted articles since software was not sold and only license to use was granted. Further, when software was supplied through a medium of CD, the taxpayer has only license to use the same. ___________________ 3 Autodesk, Inc. & Another v. Mr. Prashant Deshmukh & Others [CS(OS) No. 1755/2003, dated 9 March 2011] 4 Microsoft Corporation & Anr v. Mr. Dhiren Gopal & Ors [IA Nos.13867 of 2009 and 13868 of 2009 in CS (OS) No.2027 of 2009 dated 7 December, 2009] 5 CIT v. Synopsis International Old Ltd. [2013] 212 Taxman 454 (Kar) Samsung Electronics Ltd.[2012] 345 ITR 494 (Kar), CIT v. Sunray Computers (P) Ltd [2012] 348 ITR 196 (Kar), Citrix Systems Asia Pacific Pvt. Ltd.[2012] 343 ITR 1 (AAR), Microsoft/Gracemac Corporation v. ADIT [2010] 42 SOT 550 (Del)
  3. 3. © 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.  Separate agreement for supply of software was not only with LTGL but also with various other foreign companies for use in the telecom network by virtue of separate agreements and it indicates that software was not supplied along with hardware.  In this case the software works on hardware, but the software supplied was neither an integral part of purchase of equipment required nor was embedded software and therefore, the facts in the case of Motorola and Nokia are entirely different. The delivery of the software was separate in the form of CD and was installed in India separately.  LTGL has not been supplying software as part of equipment purchased but as a stand-alone software agreement entered into as per the EULA.  The Karnataka High court in the case of Synopsis International Old Ltd. 10 held that in terms of the tax treaty the consideration paid for the use or right to use the confidential information in the form of computer programme software itself constitutes royalty and attracts tax. It is not necessary that there should be a transfer of exclusive right in the copyright. It was held that payment for supply of software and granting of end user software license amounts to 'royalty'.  The Karnataka High Court in the case of Samsung Electronics Ltd. has held that a right to make a copy of the software and use it for internal business by making copy of the same and storing it on the hard disk amounts to use of the copyright under Section 14(1) of the Copyrights Act because in the absence of such a license, there would have been an infringement of the copyright.  In the case of Samsung Electronics Ltd. it was further held that the transaction did not involve a sale of a copyrighted article. The amount paid for supply of the ‘shrink-wrapped’ software is a combination of the price of the CD, software and the license granted. The right that was transferred was the transfer of copyright and payment made in that regard would constitute royalty.  The Tribunal held that the principles laid down by the High Court in the cases of Samsung and Synopsis was applicable to the facts of the present case. The Tribunal also relied on AAR ruling in the case of Citrix Systems Asia Pacific Pte Ltd. 11 .  Further, the decision in the case of Lucent Technologies 12 has not been upheld by the High Court. Subsequently, the Karnataka High Court in the case of Sunray Computers (P) Ltd. 13 held that supply of software was to be considered as royalty. _________________ 10 CIT v. Synopsis International Old Ltd [2013] 212 Taxman 454 (Kar) 11 Citrix Systems Asia Pacific Pte Ltd [2012] 343 ITR 001 (AAR) 12 Lucent Technologies International Inc. v. DCIT [2009] 28 SOT 98 (Del) 13 CIT v. Sunray Computers (P) Ltd. [2012] 348 ITR 196 (Kar)  The Tribunal followed the decision of the Karnataka High Court in the case of Sunray Computers (P) Ltd. on same terms of agreement as against the decision of the Delhi Special Bench Tribunal’s decision in the case of Motorola which was rendered in a different fact situation.  In all the tax treaties of India with the countries from where the taxpayer purchased software, the terms of tax treaty are similar, though restricted in meaning when compared to the definition of royalty under the Act.  Under various agreements, entered into by the taxpayer, license to use the copyright belonging to the non-resident was transferred, subject to the terms and conditions of the agreement and the non-resident supplier continues to be the owner of the copyright and all other intellectual property rights.  It is well settled that copyright is a negative right and it is an umbrella of many rights. License was granted for making use of the copyright in respect of shrink wrapped software under the respective agreement. This license authorises the end user (i.e. the customer) to make use of the copyright contained in the said software, which is purchased off the shelf or imported as shrink wrapped software.  This amounts to transfer of part of the copyright and transfer of right to use the copyright as per the terms and conditions of the agreement. Therefore, there was transfer of copyright under the agreements entered into by the taxpayer with the non-resident supplier of software.  Accordingly, the payments made by the taxpayer to LTGL/ other suppliers can be said to be payment for the use of or right to use copyright and it constituted royalty under Article 12(3) of the tax treaty. Therefore, withholding of tax was required under Section 195 of the Act. Our comments The taxability of software related payments has been a matter of debate from a long time. The Finance Act, 2012 amended Section 9(1)(vi) of the Act to provide that royalty include transfer of all or any right for use or right to use a computer software (including granting of license) irrespective of the medium through which such right is transferred.
  4. 4. © 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. Subsequently, various Courts/Tribunal 14 have held that the royalty payment related to software is taxable by virtue of aforesaid retrospective amendment to Section 9(1)(vi) of the Act. However, such payments are not taxable under the relevant tax treaty since there is no corresponding change in the tax treaty. However, the Mumbai Tribunal in this case has held that the license granted to the user/purchaser authorises the user to make use of the copyright software contained in the shrink wrapped software and amounts to transfer of part of rights of the copyright holder. Accordingly, the payments made by the taxpayer to non-resident software suppliers constitute royalty under various tax treaties as well as under the Act. Note: The Tribunal has dealt with several other issues in this decision. However, this flash news is prepared only on the issue of royalty. _________________ 14 DIT v. Nokia Networks OY [2013] 212 Taxman 68 (Del), B4U International Holdings Ltd. v. DCIT [2012] 18 ITR 62 (Mum)
  5. 5. © 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 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 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 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 Kochi 4/F, Palal Towers M. G. Road, Ravipuram, Kochi 682 016 Tel: +91 484 302 7000 Fax: +91 484 302 7001 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.

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