Sale of copyrighted article amounts to 'royalty' - Karnataka High Court
Pursuant to the directions by the Supreme Court of India in GE India Technology Centre Private Ltd v. CIT1 (‘GE Technology’), the Karnataka High Court in CIT v. Samsung Electronics Co. Ltd2 (‘Samsung Electronics’) was called in to re-examine the taxability of the payments made to a non-resident company would amount to ‘royalty’. The Supreme Court in GE Technology dealt with the broad question as to whether any payments made by a resident to a non-resident company, irrespective of whether they were chargeable under the Income-tax Act, 1961 (‘the Act’), would be subject to withholding tax (‘WHT’) under section 195 of the Act. The Supreme Court held that only such payments, as were chargeable under other parts of the Act, could be subject to WHT under section 195.
In this backdrop, the Bangalore High Court in Samsung Electronics held that payments by residents to non-residents for purchase of off the shelf software amounts to ‘royalty’ and therefore, tax has to be withheld under section 195 of the Act.
The various transactions involved by the taxpayers with non-residents were:
Initially, the Assessing Officer (‘AO’) passed an order holding that the payments in all the above transactions amounted to ‘royalty’ under Explanation 2 to section 9(1)(vi) of the Act and therefore, tax had to be ‘withheld at source’ by the taxpayers. On applying provisions of the respective DTAAs, the rate of WHT was reduced to 10%. Additionally, penalty was also imposed on the taxpayer.
Aggrieved by the said order, the taxpayers herein approached the Commissioner of Income Tax (Appeals) [‘CIT(A)’] who confirmed the order passed by the AO. Against which, an appeal was preferred before the Income Tax Appellate Tribunal (‘ITAT’) which was decided in favor of the taxpayer that such payments do not amount to royalty. On department’s appeal before the Bangalore High Court, the matter was ruled against the taxpayer. However, on appeal to the Supreme Court, the Supreme Court set aside the order of the High Court by analyzing section 195 of the Act and remanded the matter to the High Court for fresh consideration based on certain Supreme Court’s observations in GE Technology.
Arguments and Ruling
Arguments of the taxpayers
The taxpayer contended before the High Court that the said payment would not amount to ‘royalty’ within the meaning of Section 9(1)(vi) as the transaction was in the nature of a sale and not a license. No copyright or part of any copyright has been licensed to the taxpayer and the sale was simply off the shelf. The proprietary rights in the software continued to subsist with the non-resident owner and the use of the software by the taxpayer was limited to making backup copy and redistribution.
Further, since the transaction was in the nature of ‘sale’ and not ‘license’, and given that there was no permanent establishment (‘PE’) of the non-resident owner in India, such income would not be taxable in India as business income also.
The taxpayer relied on TCS v. State of Andhra Pradesh3 (‘TCS’) where the Supreme Court held that in a transfer of incorporeal right in a software wherein copyright remains with the originator, what is actually sold is the copy of the copyrighted software and not the copyright itself. Furthermore, the taxpayer relied on OECD commentary and other Supreme Court judgments to establish that only copies of the software were procured and not the copyright itself. Even though the agreement with the non-resident company uses the word ‘license’, there is no license or assignment involved in the transaction as per the Copyright Act.
It was argued in one of the appeals that the taxpayer was involved only in handing over the articles to the ultimate customers and at times the article was directly sent to them and as such the tax payer did not use the software involved.
Arguments of the revenue
The revenue argued that even if it was a sale, it would still be taxable in India as business income even without a PE and for this he relied on certain judgments4. On the other hand, the revenue argued that the transaction was in fact a license agreement since the rights granted to the taxpayer would not have been available had it not been for the said agreement, therefore, the payments would amount to royalty and not sale. The revenue distinguished the case of TCS that the issue was in relation to sales tax and not royalty.
The revenue further argued that even if the payment was made for use of copyrighted article, then in view of the explanation in section 9(1)(vi) of the Act, ‘royalty’ means consideration including lump sum payment for transfer of all or any rights for imparting any information concerning the use of copyright work in which copyright vests with the non-resident company.
Ruling of the Court
The High Court had to decide the matter in the light of the Supreme Court’s observation that section 195 uses the word chargeable and therefore, only those payments which are chargeable to tax in India would be subject to WHT. The Supreme Court referred to certain cases5 that unless the income is chargeable to tax in India, there is no need for withholding any tax in India.
The High Court held that ‘royalty’ has been explained in section 9(1)(vi) as being a consideration for the transfer of all or any of the rights in respect of a copyright. Further, the court read the definition of royalty under the governing DTAA in line with the Supreme Court decision in Azadi Bachao Andolan6 that provisions of the DTAA were to be construed narrowly such that they acted to the benefit of the taxpayer. Accordingly, an examination of Article 12 of the DTAA between India and the USA defined ‘royalty’ as a payment of any kind received as consideration for the use of or the right to use any copyright. The High Court then proceeded to examine whether the resident company, by way of such an agreement, acquired the ‘right to use’ a copyright of the non-resident company under the DTAA.
The court then opined that copyright is an umbrella of rights, and therefore, when a product is sold which has copyright imbibed in it, then there is transfer of part of the copyright and transfer of right to use the copyright for internal business. Further, the court did not heed the ratio laid down in TCS and distinguished it by stating that it was in the context of sale of goods and not on royalty. The court explained that if the owner of the copyright continued to exclusively possess proprietary rights over the software, and by way of an agreement, transferred a right of use of such copyright, such a right could be termed ‘license’ and a payment in lieu thereof could be deemed to be ‘royalty’.
The court proceeded to explain, referring to the Copyright Act, that when the copyright holder (non-resident) could sue the taxpayer (Samsung Electronics) in the event if any reproduction was made de hors the agreement, then, what was granted by way of the agreement was a license, and therefore, any fee in return thereof would be ‘royalty’. Finally, the court distinguished the example of purchasing a book vis-à-vis the purchase of computer software in a CD. It held that since a license has to be separately granted for use of software in a CD, there is no similarity with that of purchasing a book which is supported by the fact that section 14 of the Copyright Act deals separately with literary works of computer software and that of books, etc.
The Supreme Court’s ruling in TCS was that sale of computer software off the shelf does not part away with it the incorporeal rights attached to the copyright and is merely a sale of a copyrighted article. However, the High Court did not appreciate this argument on the point that TCS did not deal with royalty and was only in the context of sale of goods.
The bone of contention is, what really is the difference between ‘sale of a software’ and ‘licensing of a software’ when the copyright continues to subsist with the owner. From the point of view of income tax, this distinction is vital because in case of sale there is no royalty involved as the same could only be taxed as business income and further, sale is excluded from the definition of royalty under section 9(1)(vi). However, if the same is treated as licensing and if there is ‘use’ or ‘right to use’ of the copyright, there is royalty involved in it.
The ‘use’ of copyright involves the exercise of exclusive rights of the real owner of the copyright such as sale, reproduction, to perform in the public, translation, etc. If such rights are transferred, then the bright line between sale and license diminishes and would be liable to tax under the Act and the relevant DTAA as royalty.
However, one has to wait to see how the Supreme Court would decide on this issue (if the taxpayer prefers an appeal) especially in the light that it had provided certain guidelines while remanding this case to the High Court.
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1 327 ITR 456
2 ITA No. 2808 of 2005 and other connected appeals
3 2004 ITR (Vol. 271) 401
4 AAI, In Re (2010) 323 ITR 211; Worley Parsons Services Pty Ltd (2009) 312 ITR 317; Gracemac Corpn v. ADIT ITA 1331/ Del/ 2008; etc
5 Cooper Engineering, Czech Ocean Shipping International, Transmission Corporation and Eli Lilly
6 Union of India v. Azadi Bachao Andolan and Ors., 263 ITR 706