1 December 2014 EY Tax Alert Hyderabad Tribunal reaffirms the distinction between use of copyright right and copyrighted article Executive summary Tax Alerts cover significant tax news, developments and changes in legislation that affect Indian businesses. They act as technical summaries to keep you on top of the latest tax issues. For more information, please contact your EY advisor. This Tax Alert summarizes a recent ruling of the Hyderabad Income Tax Appellate Tribunal (Tribunal) in the case of M/s Bartronics India Ltd. [1] (Taxpayer) on the issue of taxability of payment for right to use smart card source code operating system for transport applications. This is examined under the provisions of the India-Singapore Double Taxation Avoidance Agreement (DTAA). The Taxpayer made payments to certain Singapore-based entities (SingCos) for purchase of certain software on a non-exclusive and non-transferable basis for the Taxpayer to use in respect of its own business. These payments were made without withholding any tax at source. The Tribunal, having regard to the nature of rights provided for in the license agreement, concluded that the payment was for a readymade off the-shelf computer program, that was akin to purchase of a product. Furthermore, this was meant to be only used internally by the Taxpayer. Therefore, the payment was not for use of or right to use a copyright right but, rather, for use of a copyrighted article. Having regard to the provisions of the DTAA, this should not be treated as royalty but as business income of SingCos, which was not taxable in the absence of its permanent establishment in India. [1] [TS-712-ITAT-2014(HYD)]
Facts and background Tribunal s ruling Under the provisions of the DTAA, payment for use of or right to use a copyright is characterized as royalty. The OECD Commentary distinguishes between payment for copyright and payment for a copyrighted article. While the former is treated as royalty, the latter is treated akin to purchase of goods and, hence, in the nature of business profits. The Taxpayer was an Indian company engaged in the business of providing enterprise solutions based on smart cards, bar coding, biometrics etc. During a survey in the premises of the Taxpayer, the Tax Authority noticed that certain payments were made to Singapore-based trading houses (SingCos) for source code/software in respect of smart cards operating systems for transport applications on which no tax was withheld. SingCos were mere intermediaries or trading agencies and not software developers. The Tax Authority was of the view that, as the source code was received along with intellectual property (IP) rights, the aforesaid payments to SingCos were liable to tax in India. On appeal, the First Appellate Authority held that the payments were neither in the nature of royalty nor Fees for Technical Services, since SingCos transferred the source code merely as a stock-in-trade in their capacity as trading agencies. Therefore, the Taxpayer was not required to withhold tax on payments for purchase of off-the-shelf computer program/software. Aggrieved, the Tax Authority preferred an appeal before the Tribunal. Nature of payments; royalty or business income? The Tax Authority agreed with the Taxpayer that SingCos were in the business of trading in the unique source code item held as stock-in-trade and, hence, constituted business income of SingCos. In order to qualify as royalty payment under the DTAA, the Taxpayer should have been granted use of or the right to use of copyright. Reliance placed on Supreme Court decision in the case of Tata Consultancy The Supreme Court (SC), in the case of Tata Consultancy [(2004) 271 ITR 401 (SC)], had laid down that computer programs are the product of an intellectual process, but once implanted in a medium, they are widely distributed to computer owners. Therefore, the fact that a computer program may be copyrightable as IP does not alter the consequence that, once in the form of a floppy disc or other medium, the program is tangible, moveable and available in the marketplace. The SC had further held that the purchaser of computer software neither desires nor receives mere knowledge but, rather, receives a certain arrangement of matter that will make his computer perform a desired function. This arrangement of matter, physically recorded on some tangible medium, constitutes a corporeal body. Ascertaining nature of rights available to the Taxpayer Issue before the Tribunal Whether payments to SingCos were taxable in India in terms of the provisions of the Indian Tax Laws (ITL) and the DTAA. The license agreements show that that license is non-exclusive, non-transferable and the software has to be used in accordance with the agreement. The software includes a license authorization device which restricts the use of software. Furthermore, the software is to
be used only for the licensee s (i.e., the Taxpayer s) own business. In order to treat the consideration paid by the Taxpayer as royalty, it is to be established that the Taxpayer obtained all or any of the copyright rights of such literary work. any further right to deal with them independently. Hence, acquisition of copyrighted article does not result in transfer/conferment of the copyright in it. Parting of IP essential for royalty classification Distinction between copyright right and copyrighted article Distinction has to be made between acquiring a copyright right and a copyrighted article. Copyright 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 also has the copyright in it. It does not amount to transfer of all, or any, right, including license in respect of copyright. 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. Rights which merely enable the user to effectively operate or utilize the program should be disregarded in analyzing the character of the transaction for tax purposes, such as right to copy the program on the computer or make an archival copy, as these are essential steps in utilizing the program. Royalty payment for transfer of copyright rights should be distinguished from consideration for transfer of copyrighted articles where the owner retains 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, coextensive with the owner/transferor who divests himself of the rights he possesses in his favor. As against that, in case of a copyrighted article, the licensee is merely authorized or enabled to avail the benefit of data or instructions contained therein, without Where the purpose of the license 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. The parting of IP rights inherent in and attached to the software product in favor 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 using the copyright. Application to the facts of the Taxpayer s case In the case under consideration, the Taxpayer was not allowed to commercially exploit the computer software; it was permitted to make only one copy of the software and was allowed to use the software only for its own business, as specifically identified. It was not allowed to loan/rent/sale/sub-license or transfer the copy of software to any third party without the consent of SingCos. The license agreement stipulated that all copyrights and IP rights in the software were owned by SingCos and, hence, the incorporeal right to the software i.e., the copyright was not transferred by the Taxpayer. What the Taxpayer has acquired is only a copy of the copyrighted article, whereas the copyright remained with the owner. What was transferred is 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. This is clearly distinct from the rights in a copyright. This does not give rise to any royalty payment but a payment constituting business income for the recipient. Accordingly, the Taxpayer is not required to withhold tax on such payments in the absence of a business presence of SingCos in India. Since the provisions of the DTAA are beneficial, the transaction has not been examined in terms of the ITL provisions. Comments Classification of cross-border software payments as royalty or business profits is a contentious issue in India. This ruling succinctly brings out the distinction between a copyright right and copyrighted article. Though the transaction under consideration was for purchase of software, along with codes/ instructions, the Tribunal appreciated the fact that the Taxpayer was not permitted to independently deal with or exploit the code/software but was allowed to use it for its own internal business alone on a non-exclusive and non-transferable basis. The Tribunal, in this decision, has reaffirmed the principle that a distinction between copyright right and copyrighted article should be made after ascertaining the nature of rights relating to use and exploitation of the copyright right that has been parted with by the owner in favor of the licensee. While analyzing the issue, the Tribunal has drawn support from various earlier rulings, including Motorola Inc. [2], Ericsson A.B. [3] and Dassault Systems K.K. [4]. [2] [(2005) 147 Taxman 29 (Delhi SB)]. Refer EY Tax Alert dated June 2005 on this ruling. [3] [(2012) 343 ITR 470 (Del HC)]. Refer EY Tax Alert dated 28 December 2011 titled, Delhi HC ruling on business connection and tax treatment of payments for software bundled with hardware. [4] [(2010) 322 ITR 125 (AAR)]. Refer EY Tax Alert dated 10 August 2010 titled, AAR rules on taxability of software payments.
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