Recently, Hon’ble Delhi High Court passed a judgment in the case of DIT v Infrasoft Ltd, USA. This judgement again highlighted the controversy surrounded on the taxability of consideration for sale/licence of software in India
Facts of the case:
The assessee M/s Infrasoft Ltd., a USA software marketing and development company, set up a branch office (Licensee) in India for the supply of software called “MX”. The software was customized for the requirements of the customer. The Indian branch imported the software package in the form of floppy disks or CDs and delivered it to the customer. The delivery of the system entailed installation of the software on the computers and training of the customers for operation of the system.
The licensing Agreement showed that the license 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 the copies were exclusive property of Infrasoft. The software was to be used only for Licensee’s own business. Without the consent of the Assessee the software could not be loaned, rented, sold, sublicensed or transferred to any third party or used by any parent, subsidiary or affiliated entity of the Licensee or used for the operation of a service bureau or for data processing. The licensee was further restricted from making copies, decompile, disassemble or reverse-engineer the software without Infrasoft’s written consent. The software contained a mechanism which Infrasoft could activate to deny the Licensee use of the software in the event that the Licensee was in breach of payment terms or any other provisions of the Agreement. All copyrights and intellectual property rights in and to the software, and copies made by Licensee, were owned by or duly licensed to Infrasoft.
Under Article 12 of the India-USA Double Taxation Avoidance Agreement (DTAA), “payments of any kind in consideration for the use of, or the right to use, any copyright of a literary, artistic or scientific work” is deemed to be “royalty”.
Under the Copyright Act, 1957, a software programme constitutes a “copyright”.
The Assessing Officer (AO) & Commissioner of Income Tax (Appeals) [CIT(A)] held that the software was a “copyright” and the income from its license was assessable as “royalty” under Article 12(3) of the DTAA.
On appeal by the Assessee, the Income Tax Appellate Tribunal (ITAT) held, following Motorola Inc., Ericson Radio system AB and Nokia Networks OY v. Deputy CIT 270 ITR (AT) (SB) 62, that the amount received by the Assessee under the license agreement for allowing the use of the software was not “royalty” either under the Income Tax Act or under the DTAA.
Aggrieved by the decision of the ITAT, the Revenue filed the appeal before the Delhi High Court. Before the High Court, the Department argued that in view of CIT vs. Samsung Electronics 345 ITR 494 (Kar), the right to make a copy of the software and storing it amounted to copyright work u/s 14(1) of the Copyright Act and payment made for the grant of a license for the said purpose would constitute royalty.
Judgment:
The High Court held that in order to qualify as a royalty payment under Article 12(3) of the India-USA DTAA, it is necessary to establish that there is a transfer of all or any rights (including the granting of any license) in respect of a copyright of a literary, artistic or scientific work. There is a clear distinction between acquisition of a “copyright right” and a “copyrighted article”. Copyright is distinct from the material object, copyrighted. Copyrighted is an intangible incorporeal right in the nature of a privilege, quite independent of any material substance, such as a manuscript. Just because one has the copyrighted article, it does not follow that one has copyright in it also. It does not amount to transfer of all or any right including license in respect of copyright. Copyrighted 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.
There is distinction between royalty paid on transfer of copyright and consideration for transfer of copyrighted articles. Right to use a copyrighted article or product with the owner retaining his copyright, is not the same thing as transferring or assigning rights in relation to the copyright. The enjoyment of some or all the rights which the copyright owner has, is necessary to invoke the royalty definition. Viewed from this angle, 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 DTAA. Where the purpose of the licence or the transaction is 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. The parting of intellectual property rights inherent in and attached to the software product in favour of the licensee/customer is what is contemplated by the DTAA. Merely authorizing or enabling a customer to have the benefit of data or instructions contained therein without any further right to deal with them independently does not, amount to transfer of rights in relation to copyright or conferment of the right of using the copyright. The transfer of rights in or over copyright or the conferment of the right of use of copyright implies that the transferee/licensee should acquire rights either in entirety or partially co-extensive with the owner/ transferor who divests himself of the rights he possesses for so much.
The license granted by the Assessee was limited to those necessary to enable the licensee to operate the program. The license granted to the licensee permitting him to download the computer programme, copying to the computer’s hard disk and storing it in the computer for his own use is only incidental to the facility extended to the licensee was an essential step in utilizing the program and 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 Article 12 because it is only integral to the use of copyrighted product. Apart from such incidental facility, the licensee had no right to deal with the product just as the owner would be in a position to do. Consequently there was no transfer of any right in respect of copyright by the assessee and it was a case of mere transfer of a copyrighted article. The payment was for a copyrighted article and represented the purchase price of an article and could not be considered as royalty either under the Income-tax Act or under the DTAA Therefore, rights in relation to these acts of copying, where they do no more than the enable the effective operation of the program by the user, should be disregarded and payments in these type of transactions should be treated as business income.
The licensee was not allowed to exploit the software commercially. The licensee to whom the Assessee company sold/licensed the software was allowed to make only one copy of the software and associated support information for backup purposes with a condition that such copyright shall include Infrasoft copyright and all copies shall be exclusive properties of Infrasoft.
The incorporeal right to the software i.e. copyright remains with the owner and the same was not transferred by the Assessee. The right to use a copyright in a programme is totally different from the right to use a programme embedded in a cassette or a CD which may be a software and the payment made for the same cannot be said to be received as consideration for the use of or right to use of any copyright to bring within the definition of royalty as given in the DTAA. What the licensee has acquired was only a copy of the copyright article whereas the copyright remains with the owner and the Licensees have acquired a computer programme and thus the payment for the same is not in the nature of royalty within the meaning of Article 12(3) of the DTAA.
Thus, the High Court dismissed the appeal of revenue and decided in the favour of tax payer.