Tax Hotline November 30, 2010

Reliance v. Microsoft: Tax Battle on Copyright

The Mumbai bench of the Income Tax Appellate Tribunal (“Tribunal”) in the Reliance case1recently adjudicated on the tax treatment of transactions involving payments for the license of software. Clubbing several common appeals filed by the Revenue Department, the Tribunal relying on judicial pronouncements and relevant commentaries reiterated the distinction between the purchase of a copyrighted article as juxtaposed to the copyright itself. The Tribunal opined that, a transaction involving the payment for purchase of a copyrighted article does not fall within the ambit of ‘royalty’ under Article 12 of the India-US Tax Treaty (“Treaty”).

Factual Matrix

The case at hand dealt with the issue of payment for license of software from companies resident in the US. In the present case, Reliance Industries Limited (“Reliance”) entered into a license agreement with M/s TIBCO Software Inc. (“TIBCO”) under which it obtained a perpetual, non-excusive and unlimited license for the use of software for internal operations such as ASP services and Web Hosting services. The Assessing Officer (“AO”) after examining relevant provisions of the Copyright Act, 1957 and the Income Tax Act, 1961 (“ITA”) directed Reliance to deduct tax at source under section 195 (2) of the ITA, since the said license was for the use of software and was taxable both under the ITA and the Treaty as royalty. Given that the definition of ‘royalty’ under the ITA includes a transfer of all / any rights in respect of, a patent, invention, secret formula or other such similar property, the AO was of the view that the software could also be termed as patent or invention and scientific work. The AO relied on Klaus Vogel’s commentary on Double Taxation in this regard. On appeal, this order was reversed by the Commissioner of Income Tax. The two important issues that were raised by Reliance before the Tribunal were firstly, whether payment for such software was in the nature of business receipts and secondly, whether such payment could be considered royalty, thereby attracting income tax in India.

Drawing from the agreements the Tribunal highlighted that the software so purchased was solely for internal operation and the purchaser had no right to use, copy, duplicate or display except as agreed. The general terms of the agreement which assume relevance to the case at hand and were:

(i) restriction on the use of the software for ASP Services on behalf of third party;

(ii) restriction on the right to use, copy, make copies, duplicate or display the software except as agreed;

(iii) restriction on access to the software other than to the persons agreed;

(iv) restriction on sale, license, distribute, pledge, lease, rent or commercially share the software or rights therein;

(v) restriction on the use of software for the purposes of providing a service bureau, including third party hosting / application etc;

(vi) restriction on modifying, translating, reversing, engineering, decrypting, decompiling, disassembling etc. of the source code or underlying ideas or algorithms.

Therefore, Reliance did purchase the software which was solely for certain specified limited purposes. Further, the non-resident companies / parties from whom such software was obtained did not have any permanent establishment in India.

Copyright vis-à-vis Copy of Copyrighted Article

Inextricably linked to determining whether the payment for license of software is taxable as royalty is whether the transfer results in the transfer of copyright of the article or merely a transfer / purchase of the copy of a copyrighted article. Relying on the Samsung2 case the Tribunal drew a distinction between acquiring a copyright and acquiring a copy of the copyrighted article (i.e. software) whereby in the case of sale / purchase of a copyrighted article the copyright of the article remains with the foreign party. In this case it was held that the payment for acquiring such software would not be considered ‘royalty’ since the price paid in such a case represents only the purchase price of the article. The Tribunal referring to Section 14 of the Copyright Act, 1957 and the Motorola3case further elaborated this distinction by specifying the four rights which, if acquired would resulting in owning a copyright :

(i) right to make copies of the computer programme for purposes of distribution to the public by sale or other transfer of ownership, or by rental, lease, or lending

(ii) right to prepare derivative computer programmes based upon the copyrighted computer programme

(iii) right to make a public performance of the computer programme

(iv) right to publicly display the computer programme

In its order, the Tribunal examined the (limited) end use of the software to decide on the issue of whether payment for license of software was royalty and therefore subject to tax in India. The approach adopted to characterize the transfer was to ascertain whether there has been a transfer of the copyright of the software. The Tribunal held that computer software after being put on to a media becomes a good. Given that the software was purchased by Reliance for the limited purpose of internal use only, and that the copyright remained with the owner as the right to make copies, display etc was not transferred to Reliance, the payment was not considered royalty under the ITA or the Treaty. Relying on the OECD model commentary the Tribunal further, held that acquiring a copy of a computing programme would not be treated as payments for the right to use the copyright in the same, hence would not becovered by Article 12 of the Treaty. The payment would be taxed as business profit only if the non-resident party has a permanent establishment in India, in the absence of which no Indian tax was required to be deducted at source for the said payment.

Lessons Learnt

This ruling only adds to the looming uncertainty to the Revenue’s approach of how such transactions involving the sale of software, are taxed. While on the one hand the Delhi Tribunal in its recent Microsoft ruling4 has taken the view that holding that consumers are granted a license to use the software and therefore payments made in lieu thereof is in the nature of ‘royalty’ liable to tax both under the ITA and the Treaty, the Mumbai Tribunal has decided otherwise.5 Ultimately, the specific facts on the use of such software (i.e. end use restrictions) would determine whether such sale / purchase would be treated as a transfer of copyright or merely a sale of goods.

Additionally the Tribunal has reaffirmed the importance of the OECD model commentary as an essential aid of interpretation in taxing cross-border transactions by applying tax laws in harmony with the established and well recognized principles of international tax law.

However, there seems to be a lack of uniformity and consistency in the judicial trend adopted by Indian Courts in deciding cases which involve payment for license of software to non-resident sellers. But what seems rather certain is the growing importance of such transactions given the several cases with similar facts have been adjudicated upon. Therefore, it is of extreme importance for a higher judicial body to provide the much needed clarity and finality in deciding the tax treatment meted out to the sale of a copy of a copyrighted article. In the meanwhile, structuring / documenting agreements so as to ensure the end use of license of software is restricted so as to not be treated a transfer of copyright (for instance, the limited use for internal purposes or the restrictions on making copies of the software) would be central to determine whether payment in this regard would be treated as royalty or not.


 -    Aditi Mukundan & Abhay Sharma




1 DIT v. Reliance Industries Ltd., 2010 TII 154 ITAT MUM INTL.

2 ITA No. 2808 to 2810 of 2005 and others;

3 (2005) 179 Taxman 79

4 2010-TII-141-ITAT-DEL-INTL.;

5 ADIT v M/s Solid Works Corporation AIT-2010-160-ITAT

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