Pune ITAT: Payment for use of software is not a royalty under India-Germany DTAA

Case law synopsis: Pune ITAT follows Delhi High Court not Karnataka High Court on the issue of whether software payments are covered under the definition of royalty (Allianz SE vs. Asstt. DIT)

Facts of the case:

The appellant M/s Allianz AG is a company incorporated inGermany and is engaged in the business of providing insurance and other financial servicesworldwide. The appellant owns 26% of the shareholding in Bajaj Allianz Life Insurance Co Ltd and Bajaj Alliance General Insurance Co. Ltd.in India (‘Indian affiliates’).

The appellant entered into separate Opus Software License Agreements with its Indian affiliates whereby the latter companies were granted the right to use the Opus software.

Opus software is an insurance business software solution,based on Global Insurance Operating Solution (‘GIOS software’) which has been developed by CGI Group (Europe) Ltd (‘CGI’). GIOS software is used by the insurance companies worldwide and its copyright is owned by CGI. The AllianzSE Group acquired the user rights of GIOS software from CGI and extended the functionality of certain modules of GOIS to suit the business requirements of its Group, referred to as ‘Opus Software’.

The Indian affiliates have been granted simple, non-exclusive and non-transferrable right to use the Opus Software. Further, the Indian affiliates were authorized to produce back-up copies only for archiving purposes. Furthermore, under the terms of the License agreementthe users were specifically prohibited from changing, translating or decompiling of the software and renting, leasing or selling of software or putting it up for someone’s disposal free of charge.

Revenue’s contentions:

·        As per the revenue, the aforesaid license charges fall under Article 12 of the Double Taxation Avoidance Agreement (‘DTAA’) between India Germany and accordingly the same are liable to be taxed as royalty at the rate of 10%.

·       Revenue contended that since it is only the right to use the software which has been transferred, the same is liable to be treated as royalty within the meaning of 9(1)(vi) of the Income Tax Act (‘the Act’) read with Explanation thereof.

·         Revenue further submitted that the Indian affiliates that have utilized the Opus software for the purposes of their respective businesses, which constitutes commercial exploitation of the software. Therefore, consideration paid for the same should be categorized as a royalty payment.

·         Revenue relied on the following judgements in support of its assertion: AAR in the case of IMT Labs (India) P Ltd and the Hon’bleKarnataka High Court in the case of CIT v. Samson Electronics Co. Ltd 320 ITR 209 (Kar).

Appellant’s contentions:

·         The license charges have been received only for granting the right to use Opus software for the internal business purposes and it does not entail the grant of any copyright.

·         The payments made to the appellant for the use of the Opus software, which is a copyrighted article and is not for awarding of any copyright therein, therefore not in the nature of royalty payments.

·         The appellant relied upon the following judgements in support of its claim: (i) Motorola Inc. v. DCIT (95 ITD 269) (SB), (ii) Samsung Electronics Co. Ltd. vs. ITO (93 TTJ 658) (Bang. Trib.), (iii) DCIT vs. Metapath Software International Ltd. 9 SOT 305 (Del. Trib.)

The Pune Bench decided:

·       ITAT placed reliance on the ruling of the Special Bench in Motorola Inc and observed:“In fact, in so far as the factual aspect is concerned, the Assessing Officer has clearly stated that the copyright of software vests only with the CGI Group and therefore, even from that standpoint, there can be no divergence from the assessee’s point that what has been transacted in the license agreement is only the grant of user right in the copyrighted software and not the use of copyright itself. Therefore, having regard to the factual position and the judgment of the Hon’ble Delhi High Court, wherein the decision of the Special Bench in the case of Motorola Inc. (supra) has since been approved, the view of the assessee has to be upheld.”

·   ITAT further noted that though revenue relied upon the judgements of Karnataka HC in Samsung Electronics Co Ltd and AAR in IMT Labs India P Ltd, where a contrary view was taken to the effect that consideration for grant of right to use software was taxable as royalty, however, on this issue, Pune ITAT relied upon the judgement: Solid Works Corporation’s case [TS-76-ITAT-2012(Mum)], where Mumbai bench of ITAT held that when two views were available from different HCs, the view which was favourable to the assessee should be preferred including a non-resident assesse, as per Article 24 of the DTAAbetween India and USA which provides for non-discrimination.

Our comments:

The mentioned judgement does provide relief to the appellant with the last fact finding authority i.e. ITAT when the facts of the case are on a strong footing and commensurate with the current legal position pertaining to royalty payments. However, the position of law post the passing of proposed budgetary changes suggested in Finance Bill 2012 needs to be seen, whereby it is proposed to retrospectively amend Sec. 9(1)(vi) from June 01, 1976 to the effect that consideration for transfer of user right in software would be covered within the  definition of royalty. 

Trust the same would be useful to you:

Happy Reading

Gaurav Garg/ Parul Mittal

JGarg Economic Advisors Pvt. Ltd.

New Delhi, India

(E) gaurav@jgarg.com ; parul@jgarg.com

The AAR followed Vodafone’s judgement, adopting the look-at approach and not the dissecting approach in deciding that consortium formed for bidding for tender to be assessed as AOP

Case law synopsis: The AAR followed Vodafone’s judgement, adopting the look-at approach and not the dissecting approach in deciding that consortium formed for bidding for tender to be assessed as AOP (20 Taxmann 152 (AAR) 2012)

Facts of the Case:

·       Company ‘X’ floated a Tender Notice inviting tender inquiries for carrying on the work of design, engineering, procurement, construction, installation, commissioning and handing over of the plant on a lump sum turnkey basis. The applicant along with  Company 'E' decided to come together to take up the work as a Consortium.

·       For this purpose, the applicant and Company E entered into a Memorandum of Understanding for the purpose of bidding for and taking up the work. Further, an ‘Internal Consortium Agreement' was also entered into between the applicant and Company E.

·       The tender submitted by the Consortium was accepted and the work was awarded to the Consortium. A formal agreement was entered into between Company X and the consortium companies in order to perform the work in conformity with the provisions of the contract. The Consortium took up the project work pursuant to the contract. 

·       The applicant filed an application under section 197 of the Income-tax Act (‘the Act’) taking up the position that no portion of the amount payable was liable to be withheld under section 195 of the Act, since what it performed under the contract was all off-shore and payments were received off-shore and hence not chargeable to tax in India

·       The Income-tax Officer rejected the applicant’s plea and directed Company X to withhold tax on amounts paid to the applicant in terms of the contract. It is in that situation that the applicant approached this Authority with its application under section 245Q of the Act. 

·         The following questions were put before the AAR for perusal:

1.     Whether the consortium of ABC Germany with Company E is taxable as AOP?

2.     Whether the amount receivable in respect of design and engineering, liable to tax in India under the Act or under the Double Taxation Avoidance Agreement read with Protocol between India and Germany ("DTAA")?

3.     If the answer to question no. 2 is in the affirmative, what is the rate of tax in India?

4.     Whether the amount receivable by the applicant for supply of equipment, material and spares, outside India are liable to tax in India, under the Act or DTAA?

5.     If the answer to 4 is in the affirmative, to what extent are the profits from the supply of plant and equipment taxable in India?

6.     Whether the consideration for onshore services comprising supervision of installation, testing, commissioning and construction, management/supervision is liable to tax on the profits of the PE, as may be deemed to exist in India, in terms of Section 44DA of the Act read with the provision of the DTAA.

7.     If the answer to question No. 6 is in the affirmative, whether for the purpose of determining the profits of the PE in India, the actual expenditure incurred by head office exclusively and specifically in relation to onshore activities of the PE and reimbursed to it, are allowable in full?

Revenue’s contentions:

·       The contract for erection is a lump sum turnkey contract and was an indivisible contract. Any splitting up of the contract would be artificial and cannot be resorted to. A lump sum turnkey contract for erection of a plant was a well understood form of contract and it would be unrealistic to split it up into parts just for the purpose of taxation alone.

·       The Revenue also refuted the claim of the applicant that the title to the machinery passes off-shore. It was submitted that in a supply and erection contract, when the risk is retained not merely until delivery but until acceptance of the works by Company X, which is after trial and commissioning of the project. Further, the contract does not specify that title to the machinery shall pass on to Company X on high seas or in the country of origin.

·       The members came together to undertake a contract. The motive was obviously to generate an income. The liability of the Consortium continued after installation and even after commissioning. It was a joint liability. In this situation, an AOP was formed and the assessment has to be on that basis.

Applicant’s contentions:

·       The applicant emphasizes that the contract is a divisible contract which clearly identifies the scope of work and obligations of the two Consortium members and the consideration is payable by Company X directly to each member for the work done by it.

·       The expenses incurred by each member for the part of the work performed by that member. There is no sharing of costs or receipts between the two members inter se. There is also no sharing of assets employed by each of them and there is no sharing of profit or loss. There is also no common employment of capital or resources.

Verdict:

·      The AAR followed the decision of Supreme Court in Vodafone International Holdings B.V. v. UOI and another [(2012) 341 ITR 1 (SC)], wherein it was held that section 9(1)(i) of the Act is not a 'look through' provision and that the Revenue must look at the transaction to understand its import. The Chief Justice held "it is the task of the Revenue/Court to ascertain the legal nature of the transaction and while doing so, it has to look at the transaction as a whole and not to adopt a dissecting approach." The AAR said that “To read such a contract as one for sale of goods independent of the contract as a whole and separately from the obligation undertaken thereunder to erect, commission and deliver a plant, would be adopting a dissecting approach to that contract.” Applying the 'look at' test and interpreting the terms of the contract as a whole, the contract is one and indivisible and it is not open to the applicant to attempt to split up each component of the contract for the purpose of taxation. A dissecting approach is not warranted in this case.

·       It was held that an AOP is formed in this case since the internal division of responsibility by the Consortium members and the recognition thereof by Company X or the making of separate payments by Company X to the two members, cannot dislodge the legal position of formation of an AOP by the applicant.

 

·       Since the assessment is to be as an Association of Persons and taxable in India under the Act, the question of existence or non-existence of a PE does not arise.

(Compiled by team of JGarg Economic Advisors Private Limited)