Royalty u/s Section 9(1)(6):DTAA Overrides Retrospective Amendment !

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The gloom in software business as far as the taxation issue is concerned , has perhaps over for the time being as Delhi High Court , in total contrast to decision of Karnataka High court on the issue of whether the purchase of license to use software is royalty , has held in very recent judgment in case of DIT vs Nokia Networks OY vide its order dated 7th September 2012 that

Facts of the Case of Royalty in case of Nokia Networks

Nokia is a company incorporated in Finland with which India has a Double Taxation Avoidance Agreement. Nokia has one Liaison office in India as well as an Indian subsidiary called Nokia India Private Ltd.

During this period, GSM equipment manufactured in Finland was sold to Indian telecom operators from outside India on a principal to principal basis, under independent buyer-seller arrangements. Installation activities were undertaken by Indian subsidiary under its independent contracts with Indian telecom operators. Nokia, being a tax resident of Finland, is governed by the provisions of India-Finland Double Taxation Avoidance Agreement.

The A.O passed the order u/s 143(3) against Nokia OY in the following manner:-

Nokia was carrying on business in India through a Permanent Establishment (PE) as it has both the Indian Liaison Office and Indian subsidiary .

70% of total equipment revenue (comprising of hardware and software) was attributed to sale of hardware and 40% of the same was estimated as income of Nokia from supply of hardware.

Further 30% of the profits so determined were attributed to the PE of Nokia in India.

The remaining 30% of the equipment revenues were attributed towards supply of software and the same was taxed as ‘royalty’ (on a gross basis) both u/s 9(1)(vi) of the Income-tax Act and under Article 13 of the India-Finland DTAA, holding that software was not sold but licensed to the Indian telecom operators.

Special Bench of Mumbai Tribunal  on Royalty

The assessee filed appeal before ITAT Mumbai after CIT(A) confirmed the decision of A.O. The Special Bench favoured the assessee by holding , among other things , that payment for supply of software was not in the nature of ‘royalty’ because the same was for a copyrighted article and ‘not for a copyright. Further, software was held to be integral part of GSM equipment. Payment for supply of software was held not taxable both under the provisions of the Act and under DTAA.

Delhi High Court’s Decision on Royalty issue

The Hon’ble Delhi high court on the issue whether the payment for software was royalty , maintained its earlier decision on the same issue in case of DIT v. Ericsson, 343 ITR 370 and held as under :

• 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 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”.[Para 59]
• payment received by the assessee was towards the title and GSM system of which software was an inseparable parts incapable of independent use and it was a contract for supply of goods. Therefore, no part of the payment therefore can be classified as payment towards royalty. ( This was based on Delhi High court earlier judgement in DIT v. Ericsson, 343 ITR 370)
• It is categorically held in CIT v. Siemens Aktiongesellschaft, 310 ITR 320 (Bom) that the amendments cannot be read into the treaty.