This write-up summarizes the important findings of SC on software royalty issue.
The appeals before SC were grouped into four categories:
- The first category deals with cases in which computer software is purchased directly by an end-user, resident in India, from a foreign, non-resident supplier or manufacturer.
- The second category of cases deals with resident Indian companies that act as distributors or resellers, by purchasing computer software from foreign, non-resident suppliers or manufacturers and then reselling the same to resident Indian end-users.
- The third category concerns cases wherein the distributor happens to be a foreign, non-resident vendor, who, after purchasing software from a foreign, non-resident seller, resells the same to resident Indian distributors or end-users.
- The fourth category includes cases wherein computer software is affixed onto hardware and is sold as an integrated unit/equipment by foreign, non-resident suppliers to resident Indian distributors or end-users.
Importance of DTAA
What is of importance is that once a DTAA applies, the provisions of the Income Tax Act can only apply to the extent that they are more beneficial to the assessee and not otherwise. Further, by explanation 4 to section 90 of the Income Tax Act, it has been clarified by the Parliament that where any term is defined in a DTAA, the definition contained in the DTAA is to be looked at. It is only where there is no such definition that the definition in the Income Tax Act can then be applied.
The machinery provision contained in section 195 of the Income Tax Act is inextricably linked with the charging provision contained in section 9 read with section 4 of the Income Tax Act, as a result of which, a person resident in India, responsible for paying a sum of money, “chargeable under the provisions of [the] Act”, to a non-resident, shall at the time of credit of such amount to the account of the payee in any mode, deduct tax at source at the rate in force which, under section 2(37A)(iii) of the Income Tax Act, is the rate in force prescribed by the DTAA. Importantly, such deduction is only to be made if the nonresident is liable to pay tax under the charging provision contained in section 9 read with section 4 of the Income Tax Act, read with the DTAA.
The person liable to deduct tax is only liable to deduct tax first and foremost if the nonresident person is liable to pay tax, and second, that if so liable, is then liable to deduct tax depending on the rate mentioned in the DTAA.
GE Followed, PILCOM Distinguished
With respect to Revenues reliance on PILCOM 2020 SCC Online SC 426, the SC held as follows:
It will be seen that section 194E of the Income Tax Act belongs to a set of various provisions which deal with TDS, without any reference to chargeability of tax under the Income Tax Act by the concerned nonresident assessee. This section is similar to sections 193 and 194 of the Income Tax Act by which deductions have to be made without any reference to the chargeability of a sum received by a non-resident assessee under the Income Tax Act. On the other hand, as has been noted in GE Technology (2010) 10 SCC 29, at the heart of section 195 of the Income Tax Act is the fact that deductions can only be made if the non-resident assessee is liable to pay tax under the provisions of the Income Tax Act in the first place.
Thus, the judgment of this Court in PILCOM (supra), dealing with a completely different provision in a completely different setting, has no application to the facts of this case.
End-User Licence Agreements and Distribution Agreements
Referring to various Agreements, the SC held that:
A reading of the distribution agreement would show that what is granted to the distributor is only a non-exclusive, non-transferable licence to resell computer software, it being expressly stipulated that no copyright in the computer programme is transferred either to the distributor or to the ultimate end-user. This is further amplified by stating that apart from a right to use the computer programme by the end-user himself, there is no further right to sub-license or transfer, nor is there any right to reverse-engineer, modify, reproduce in any manner otherwise than permitted by the licence to the end-user. What is paid by way of consideration, therefore, by the distributor in India to the foreign, non-resident manufacturer or supplier, is the price of the computer programme as goods, either in a medium which stores the software or in a medium by which software is embedded in hardware, which may be then further resold by the distributor to the end-user in India, the distributor making a profit on such resale. Importantly, the distributor does not get the right to use the product at all.
When it comes to an end-user who is directly sold the computer programme, such end-user can only use it by installing it in the computer hardware owned by the end-user and cannot in any manner reproduce the same for sale or transfer, contrary to the terms imposed by the EULA.
In all these cases, the “licence” that is granted vide the EULA, is not a licence in terms of section 30 of the Copyright Act, which transfers an interest in all or any of the rights contained in sections 14(a) and 14(b) of the Copyright Act, but is a “licence” which imposes restrictions or conditions for the use of computer software. Thus, it cannot be said that any of the EULAs that we are concerned with are referable to section 30 of the Copyright Act, inasmuch as section 30 of the Copyright Act speaks of granting an interest in any of the rights mentioned in sections 14(a) and 14(b) of the Copyright Act. The EULAs in all the appeals before us do not grant any such right or interest, least of all, a right or interest to reproduce the computer software. In point of fact, such reproduction is expressly interdicted, and it is also expressly stated that no vestige of copyright is at all transferred, either to the distributor or to the end-user.
An instructive judgment of this Court in this respect is to be found in State Bank of India v. Collector of Customs, (2000) 1 SCC 727. In this case, the State Bank of India imported a consignment of computer software and manuals from Kindle Software Ltd., Dublin, Ireland, and cleared the goods for home consumption, and filed an application before the Additional Collector of Customs, claiming a refund of customs duty. The judgment makes important differentiation made between the right to reproduce and the right to use computer software, has been recognized by this judgment. Whereas the former would amount to a parting of copyright by the owner thereof, the latter would not.
There can be no doubt as to the real nature of the transactions in the appeals before us. What is “licensed” by the foreign, non-resident supplier to the distributor and resold to the resident end-user, or directly supplied to the resident end-user, is in fact the sale of a physical object which contains an embedded computer programme, and is therefore, a sale of goods, which, as has been correctly pointed out by the learned counsel for the assessees, is the law declared by this Court in the context of a sales tax statute in Tata Consultancy Services v. State of A.P., 2005 (1) SCC 308 (see paragraph 27).
Definition of Royalty in the DTAA’s vis-a-vis the Income Tax Act
Firstly, it will be seen that when Article 12 of the India-Singapore DTAA defines the term “royalties” in sub-article (3) thereof, it does so stating that such definition is exhaustive – it uses the expression “means”. Secondly, the term “royalties” refers to payments of any kind that are received as a consideration for the use of or the right to use any copyright in a literary work.
As opposed to this, the definition contained in explanation 2 to section 9(1)(vi) of the Income Tax Act, is wider in atleast three respects:
- It speaks of “consideration”, but also includes a lump-sum consideration which would not amount to income of the recipient chargeable under the head “capital gains”;
- When it speaks of the transfer of “all or any rights”, it expressly includes the granting of a licence in respect thereof; and
- It states that such transfer must be “in respect of” any copyright of any literary work.
However, even where such transfer is “in respect of” copyright, the transfer of all or any rights in relation to copyright is a sine qua non under explanation 2 to section 9(1)(vi) of the Income Tax Act. In short, there must be transfer by way of licence or otherwise, of all or any of the rights mentioned in section 14(b) read with section 14(a) of the Copyright Act.
In State of Madras v. Swastik Tobacco Factory, (1966) 3 SCR 79, this Court construed the expression “in respect of” must be read as equivalent to “attributable”. It was further observed that Indian tax laws use the expression “in respect of” as synonymous with the expression “on”:
The aforesaid meaning accords with the meaning to be given to the attribute or on expression “in respect of” contained in explanation 2(v) to section 9(1)(vi) of the Income Tax Act.
The definition of royalty contained in explanation 2(v) of section 9(1)(vi) of the Income Tax Act includes the transfer of all or any rights (including the granting of a licence) “in respect of any copyright, literary, artistic or scientific work”.
The comma after the word “copyright” does not fit as copyright is obviously spoken of as existing in a literary, artistic or scientific work. As a matter of fact, this drafting error was rectified in the Draft Taxes Code 2010, 38 under Chapter XIX in Part H thereof, which set out the definition of “royalty”.
The transfer of “all or any rights (including the granting of a licence) in respect of any copyright”, in the context of computer software, is referable to sections 14(a), 14(b) and 30 of the Copyright Act. As has been held hereinabove, the expression “in respect of” is equivalent to
“in” or “attributable to”. Thus, explanation 2(v) to section 9(1)(vi) of the Income Tax Act, when it speaks of “all of any rights…in respect of copyright” is certainly more expansive than the DTAA provision, which speaks of the “use of, or the right to use” any copyright.
However, when it comes to the expression “use of, or the right to use”, the same position would obtain under explanation 2(v) of section 9(1)(vi) of the Income Tax Act, inasmuch as, there must, under the licence granted or sale made, be a transfer of any of the rights contained in sections 14(a) or 14(b) of the Copyright Act, for explanation 2(v) to apply. To this extent, there will be no difference in the position between the definition of “royalties” in the DTAAs and the definition of “royalty” in explanation 2(v) of section 9(1)(vi) of the Income Tax Act.
Even if we were to consider the ambit of “royalty” only under the Income Tax Act on the footing that none of the DTAAs apply to the facts of these cases, the definition of royalty that is contained in explanation 2 to section 9(1)(vi) of the Income Tax Act would make it clear that there has to be a transfer of “all or any rights” which includes the grant of a licence in respect of any copyright in a literary work. The expression “including the granting of a licence” in clause (v) of explanation 2 to section 9(1)(vi) of the Income Tax Act, would necessarily mean a licence in which transfer is made of an interest in rights “in respect of” copyright, namely, that there is a parting with an interest in any of the rights mentioned in section 14(b) read with section 14(a) of the Copyright Act. To this extent, there will be no difference between the position under the DTAA and explanation 2 to section 9(1)(vi) of the Income Tax Act.
Shri Pardiwala argued that explanation 4, that was inserted with retrospective effect, uses the language that is contained in section 9(1)(vi)(b) of the Income Tax Act, namely, that the expression “any right, property or information” occurring in section 9(1)(vi)(b) alone is the subject matter of explanation 4, explanation 4 not expanding the scope of the definition of royalty contained in explanation 2, which does not contain the aforesaid expression. A reference to the Memorandum explaining the provisions in the Finance Bill 2012 set out hereinabove, would make it clear that the expression “as mentioned in Explanation 2” in sub-para (i) of the aforesaid Memorandum shows that explanation 4 was inserted retrospectively to expand the scope of explanation 2(v). In any case, explanation 2(v) contains the expression, “the transfer of all or any rights” which is an expression that would subsume “any right, property or information” and is wider than the expression “any right, property or information”. It is therefore difficult to accept Shri Pardiwala’s argument that explanation 4 does not expand the scope of the expression “royalty” as contained in explanation 2 to section 9(1)(vi) of the Income Tax Act.
Likewise, even qua section 2(o) of the Copyright Act, the term “computer software” was introduced for the first time in the definition of a literary work, and defined under section 2(ffc) only in 1994 (vide Act 38 of 1994).
Furthermore, it is equally ludicrous for the aforesaid amendment which also inserted explanation 6 to section 9(1)(vi) of the Income Tax Act, to apply with effect from 01.06.1976, when technology relating to transmission by a satellite, optic fibre or other similar technology, was only regulated by the Parliament for the first time through the Cable Television Networks (Regulation) Act, 1995, much after 1976. For all these reasons, it is clear that explanation 4 to section 9(1)(vi) of the Income Tax Act is not clarificatory of the position as of 01.06.1976, but in fact, expands that position to include what is stated therein, vide the Finance Act 2012.
The learned Additional Solicitor General then argued that being covered by explanation 4 of section 9(1)(vi) of the Income Tax Act, the persons liable to deduct TDS under section 195 of the Income Tax Act ought to have deducted tax at source on the footing that explanation 4 existed on the statute book with effect from 1976. We have, therefore, to examine as to whether persons liable to deduct TDS under section 195 of the Income Tax Act can be held liable to deduct such sums at a time when explanation 4 was factually not on the statute book, all deductions liable to be made and the assessment years in question being prior to the year 2012. This question is answered by two latin maxims, lex non cogit ad impossibilia, i.e., the law does not demand the impossible and impotentia excusat legem, i.e., when there is a disability that makes it impossible to obey the law, the alleged disobedience of the law is excused.
Rulings of the AAR and Judgments Of High Courts
The conclusions that can be derived on a reading of the various judgments of HC and AAR are as follows:
- Copyright is an exclusive right, which is negative in nature, being a right to restrict others from doing certain acts.
- Copyright is an intangible, incorporeal right, in the nature of a privilege, which is quite independent of any material substance. Ownership of copyright in a work is different from the ownership ofphysical material in which the copyrighted work may happen to be embodied. An obvious example is the purchaser of a book or a CD/DVD, who becomes the owner of the physical article, but does not become the owner of the copyright inherent in the work, such copyright remaining exclusively with the owner.
- Parting with copyright entails parting with the right to do any of the acts mentioned in section 14 of the Copyright Act. The transfer of the material substance does not, of itself, serve to transfer the copyright therein. The transfer of the ownership of the physical substance, in which copyright subsists, gives the purchaser the right to do with it whatever he pleases, except the right to reproduce the same and issue it to the public, unless such copies are already in circulation, and the other acts mentioned in section 14 of the Copyright Act.
- A licence from a copyright owner, conferring no proprietary interest on the licensee, does not entail parting with any copyright, and is different from a licence issued under section 30 of the Copyright Act, which is a licence which grants the licensee an interest in the rights mentioned in section 14(a) and 14(b) of the Copyright Act. Where the core of a transaction is to authorize the end-user to have access to and make use of the “licensed” computer software product over which the licensee has no exclusive rights, no copyright is parted with and consequently, no infringement takes place, as is recognized by section 52(1)(aa) of the Copyright Act. It makes no difference whether the end-user is enabled to use computer software that is customised to its specifications or otherwise.
- A non-exclusive, non-transferable licence, merely enabling the use of a copyrighted product, is in the nature of restrictive conditions which are ancillary to such use, and cannot be construed as a licence to enjoy all or any of the enumerated rights mentioned in section 14 of the Copyright Act, or create any interest in any such rights so as to attract section 30 of the Copyright Act.
- The right to reproduce and the right to use computer software are distinct and separate rights, as has been recognized in SBI v. Collector of Customs, 2000 (1) SCC 727 (see paragraph 21), the former amounting to parting with copyright and the latter, in the context of non-exclusive EULAs, not being so.
Consequently, the view contained in the determinations of the AAR in Dassault (AAR) (2010) 322 ITR 125 (AAR) and Geoquest (AAR) (2010) 327 ITR 1 and the judgments of the High Court of Delhi in Ericsson A.B. (2012) 343 ITR 470, Nokia Networks OY (2013) 358 ITR 259, Infrasoft (2014) 264 CTR 329, ZTE (2017) 392 ITR 80, state the law correctly and have our express approval. We may add that the view expressed in the aforesaid judgments and determinations also accords with the OECD Commentary on which most of India’s DTAAs are based.
Interpretation of Treaties, OECD Commentary and the Revenue’s Own Understanding
The DTAAs that have been entered into by India with other Contracting States have to be interpreted liberally with a view to implement the true intention of the parties. SC in Azadi Bachao Andolan 263 ITR 706 held as follows:
“98. In John N. Gladden v. Her Majesty the Queen [85 DTC 5188 at p. 5190] the principle of liberal interpretation of tax treaties was reiterated by the Federal Court, which observed:
“Contrary to an ordinary taxing statute a tax treaty or convention must be given a liberal interpretation with a view to implementing the true intentions of the parties. A literal or legalistic interpretation must be avoided when the basic object of the treaty might be defeated or frustrated insofar as the particular item under consideration is concerned.””
When the definition of “royalties” is seen in all the DTAAs that we are concerned with, it is found that “royalties” is defined in a manner either identical with or similar to the definition contained in Article 12 of the OECD Model Tax Convention. This being the case, the OECD Commentary on the provisions of the OECD Model Tax Convention then becomes relevant.
With respect to India’s reservation on OECD Commentary, the SC held as follows:
From these positions taken, which use the language “reserves the right to” and “is of the view that some of the payments referred to may constitute royalties”, it is not at all clear as to what exactly the nature of these positions are.
It is significant to note that after India took such positions qua the OECD Commentary, no bilateral amendment was made by India and the other Contracting States to change the definition of royalties contained in any of the DTAAs that we are concerned with in these appeals, in accordance with its position. As a matter of fact, DTAAs that were amended subsequently, incorporated a definition of royalties, not very different from the definition contained in the OECD Model Tax Convention.
Viewed from another angle, persons who pay TDS and/or assessees in the nations governed by a DTAA have a right to know exactly where they stand in respect of the treaty provisions that govern them. Such persons and/or assessees can thus place reliance upon the OECD Commentary for provisions of the OECD Model Tax Convention, which are used without any substantial change by bilateral DTAAs, in the absence of judgments of municipal courts clarifying the same, or in the event of conflicting municipal decisions. From this point of view also, the OECD Commentary is significant, as the Contracting States to which the persons deducting tax/assessees belong, can conclude business transactions on the basis that they are to be taxed either on income by way of royalties for parting with copyright, or income derived from licence agreements which is then taxed as business profits depending on the existence of a PE in the Contracting State.
The learned Additional Solicitor General, however, relied upon the HPC Report 2003 and the E-Commerce Report 2016. The HPC Report 2003. In this regard, the SC held that these reports also do not carry the matter much further as they are recommendatory reports expressing the views of the committee members, which the Government of India may accept or reject. When it comes to DTAA provisions, even if the position put forth in the afore mentioned reports were to be accepted, a DTAA would have to be bilaterally amended before any such recommendation can become law in force for the purposes of the Income Tax Act.
Given the definition of royalties contained in Article 12 of the DTAAs mentioned in paragraph 41 of this judgment, it is clear that there is no obligation on the persons mentioned in section 195 of the Income Tax Act to deduct tax at source, as the distribution agreements/EULAs in the facts of these cases do not create any interest or right in such distributors/end-users, which would amount to the use of or right to use any copyright. The provisions contained in the Income Tax Act (section 9(1)(vi), along with explanations 2 and 4 thereof), which deal with royalty, not being more beneficial to the assessees, have no application in the facts of these cases.
Our answer to the question posed before us, is that the amounts paid by resident Indian end-users/distributors to non-resident computer software manufacturers/suppliers, as consideration for the resale/use of the computer software through EULAs/distribution agreements, is not the payment of royalty for the use of copyright in the computer software, and that the same does not give rise to any income taxable in India, as a result of which the persons referred to in section 195 of the Income Tax Act were not liable to deduct any TDS under section 195 of the Income Tax Act. The answer to this question will apply to all four categories of cases enumerated by us in paragraph 4 of this judgment.