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Authority for advance ruling holds income from sale of software products not liable to tax in India

10 Mar 2010

The tax treatment of income from sale of software products has been a contentious issue in India. The Revenue authorities ("RA") often treat this income as 'royalty" under domestic law. Under applicable Tax Treaties income is liable to tax in India stating the payer is required to withhold taxes when making payments to a non-resident. Taxand India investigates the Dassault Systems ruling and how this will impact multinationals.

Even though the Supreme Court had in the Tata Consultancy Services ruling held that off-the shelf software should be treated as goods, the RA argued that the decision was applicable only under VAT laws.

The recent decision of the Karnataka High Court in the case of Samsung Electronics which held that the requirement for tax withholding would be applicable for all payments which are prima facie in the nature of income has further complicated the matter.

Against this backdrop, the ruling from the Authority for Advance Ruling ("AAR"), in the case of Dassault Systems, holds that income from sale of software products is not liable to tax in India. This comes as a shot in the arm for companies in similar situations.

The applicant was a Japanese company which had independent software distributors in India. The distributors procured orders from end customers, based on which the applicant allowed the customers to download the products electronically. The applicant charged a discounted price to the distributors, who in turn charged the market rate to customers.

Before the AAR, the RA contended that the payments made by the distributors were for the transfer of rights in the copyright and therefore, should be treated as royalty. The RA claimed that the applicant transfered its right as a copyright holder by allowing the distributors to sell the software. The RA also referred to a recent ruling of the Special Bench of the Tax Tribunal in New Skies Satellite, where payment for the right to use a process was held to be royalty for income-tax purposes.

Accordingly, the RA contended that the payments were in the nature of royalty and that tax should be withheld on such payments.

The RA also contended that the distributors should be regarded as a Dependent Agent Permanent Establishment ("PE") of the applicant, as they act on behalf of the applicant in securing orders. Accordingly, the RA contended that the payments would be liable to tax as business income, even if they were not treated as royalty.

The applicant contended that the payments were not for copyright, but for purchase of copyrighted products. Further, the license granted does not fall within the meaning of copyright under the Copyright ("CR") Act, 1957. On this basis, the applicant claimed that the payments were liable to income-tax in the hands of the non-resident.

The AAR ruled that copyright cannot be understood differently for income-tax purposes, when it is defined under the Copyright Act. It noted that the applicant had granted only a license for the use of the copyrighted product on a non-exclusive basis and did not grant the use of copyright itself.

It held that there was a distinction between the use of copyrighted article and the use of copyright itself. If any of the statutory rights enumerated in section 14 of the CR Act were parted with in favour of the end user, it would amount to providing use of copyright. In the instant case, the end-user was not given any such statutory right. The term "granting of a license" used in the domestic law does not cover any and every license. It should derive its meaning and scope from the preceding expression "transfer of rights in respect of copyright".

The AAR also observed that the business of the distributors are not controlled by the applicant except when it is necessary to promote its own business and the distributors do not have the authority to negotiate or conclude contracts with the end-users on behalf of the applicant. The distributors were free to determine their own price while dealing with the end-users. Accordingly, the AAR ruled that the distributors cannot be treated as dependent agent PE of the applicant.

AAR is a fast track mechanism which is mandated under law to dispose of an application within six months from the date of the application.

The principal advantage in applying for a ruling is that the income-tax liability of the non-resident in relation to a particular transaction can be determined after, during or prior to undertaking the transaction and such ruling is binding on the Revenue and on the applicant. This scheme is expeditious, definitive and binding. The ruling is binding unless there is a change in law or change to the facts based on which the ruling was pronounced.

Taxand's Take

This ruling is an important one for the software industry in view of the reaffirmation of the important principles relating to copyright and copyrighted products. Even though the Samsung Electronics case involved the question of taxability of software payments, this question was not specifically dealt with by the High Court. In this background, the ruling of the AAR comes as a relief to the taxpayers. However, the rulings of AAR are binding only on the applicant and the RA. Although they do have persuasive value in other proceedings.

To fully understand the position of a taxpayer it may be worthwhile requesting an AAR.

Your Taxand contact for further queries is:
Abhishek Goenka / Mukesh Butani
T. +91 80 4032 0100 / +91 11 3081 5000
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Taxand's Take Author