CASE ANALYSIS: ENGINEERING ANALYSIS CENTRE OF EXCELLENCE PRIVATE LIMITED v. THE COMMISSIONER OF INCOME TAX & ANOTHER By- Mrudhu Bashni Rajendran
CASE ANALYSIS: ENGINEERING ANALYSIS
CENTRE OF EXCELLENCE PRIVATE LIMITED v. THE COMMISSIONER OF INCOME
TAX & ANOTHER
Authored By- Mrudhu
Bashni Rajendran
B.B.A., LL.B. (Hons.)
SASTRA DEEMED UNIVERSITY
ABSTRACT
The case Engineering Analysis Centre of
Excellence Private Limited v. The Commissioner of Income Tax & Another is a
land mark judgement which has resolved a two decades of conflict between the
income tax authorities and the tax payers. It is about the payment of consideration
by Indian companies or end users to utilize computer software purchased from
foreign sources and whether or not it is taxable as ‘Royalty’ and has also
resolved the confusion created by conflicting rulings of various adjudicating
bodies. This case combines concepts from taxation and intellectual property
rights. The case analysis begins with an introduction to the conflict regarding
the taxation of payments for the purchase of computer software in international
transactions, which is followed by a list of provisions involved along with the
facts, background, bench, and issues of the case. This is followed by the
contentions presented by the Appellants and Respondents. This is further
followed by the judgement and critical analysis of the judgement. Finally, the
case analysis concludes with a short note on the grounds of revision of the
judgement.
INTRODUCTION
One of the major points of discord
between taxpayers and tax authorities for over two decades in India has been
the controversy embracing the taxation of payments for the purchase of computer
software in international transactions. This has become the focus of extensive
litigation. The crux of the contention is related to the characterization of
income held in the hands of non-resident taxpayers as either business profits
or royalties.
The tax authorities have taken the
stance that income arising from grant of software license should be characterized
as “royalty,” without considering the nature of rights gained by the customer. On
the other hand, taxpayers have taken the stance that income from computer
software should be categorized as royalty or business income on the essence of
the nature and extent of rights granted to the customer by the terms of the
treaty.
India has entered into tax treaties
with other countries that define “royalty” as a consideration for the use or
the right to use the copyright of a literary, artistic, or scientific work.[1]
The tax treaties lack a provision like Explanation 4 of Section 9(1)(vi)(b)[2], which
has expanded the scope of the term ‘royalty’ by providing that grant of all or
any rights includes transfer of all or any right for use or right to use a
computer software.[3]
The present case of the Engineering
Analysis Centre of Excellence Private Limited v. Commissioner of Income Tax[4] is
about the payment of consideration by Indian companies or end users to utilise
computer software purchased from foreign sources and whether or not it is
taxable as royalty. This case also deals with the question of whether TDS can
be deducted for software purchased from foreign software suppliers.
This
case is interesting because it resolves a major point of discord between
taxpayers and tax authorities. It also resolves the confusion created by the
conflicting rulings of the Hon’ble High Courts of Karnataka and Delhi, as well
as the Authority for Advance Rulings (AAR). Further,
the case states that taxpayers need not do the impossible to meet the statutory
requirements created by amendment, which is to be applied retrospectively.
TAXATION STATUTORY PROVISIONS
INVOLVED IN THE CURRENT CASE
·
Sections 9(1) and (vi) of the Income Tax Act,
1961.[5]
·
Section 195 of the Income Tax Act, 1961.[6]
·
Section 201 of the Income Tax Act, 1961.[7]
FACTS OF THE CASE
In the instant case, the appellant is
an Indian resident involved in the resale of software packaged in
shrink-wrapped material imported from a non-resident company. Because the
transaction constituted sale of goods, the appellant had not deducted tax with
respect to the considerations given.
In contrast, the Department of
Revenue claimed that the transaction that happened between the parties is a
copyright for the right to use the software, which will result in royalty
payments and as a consequence assessed that under Section 195 of the Act[8]
which states that the tax should be deducted at source.
The Hon’ble Supreme Court heard two
sets of appeals, one originating from the High Court of Karnataka and the other
from the High Court of Delhi judgements. The High Court of Karnataka decreed in
favor of the Revenue, whereas the High Court of Delhi decreed in favor of the
Assesses.
When the matter was presented to the
High Court of Karnataka, the appeal was upheld, citing its verdict in the
CIT v. Samsung Electronics Co, Ltd.. & Others[9],
which ruled that what was sold as computer software includes a right or
interest in copyright, consequently resulting in the payment of royalty and
deemed to be an income of the resident as required by Section 9 (1) (vi) of the
Act, which requires the deduction of tax at source.
Civil appeals were filed with the Supreme Court by the appellant
accompanied by other assesses who were also aggrieved by the decision of the Court.
The Hon’ble Supreme Court divided the appeals into four types of
software payments:
1. An end user, who is an Indian resident, purchases computer software
directly from a foreign non-resident supplier or manufacturer.
2. Resident Indian companies resell computer software purchased from a
foreign non-resident supplier or manufacturer.
3. A foreign, non-resident vendor acts as a distributor to purchase
computer software from a foreign, non-resident seller, and resells it to
resident Indian distributors or end users.
4. Foreign, non-resident suppliers sell integrated units/equipment
consisting of computer software entangled with hardware to resident Indian distributors or end
users.
The appellant EAC fall under the second category.
BACKGROUND OF THE CASE
In one set of appeals, the Assessing
Officer decreed in favor of the Revenue Department. The Commissioner of Income
Tax dismissed the appeal. The Revenue Department also succeeded in the
Authority for Advanced Rulings (AAR) on the present issue. The Income Tax Appellate Tribunal then
decreed in favor of the appellants, and the tribunal applied its own order
passes in the case of Samsung Electronics Co., Ltd. v. Income Tax Officer[10].
The Revenue Department appealed to
the High Court of Karnataka. The High Court of Karnataka ruled in favor of the
Revenue Department. Thus, the assesses have appealed to the Hon’ble Supreme Court
of India. The other set of appeals which was judged by the High Court of Delhi
decreed in favour of the assesses in case of DIT vs. Ericsson A. B[11].
The aggrieved Revenue Department has appealed to the Hon’ble
Supreme Court. The Supreme Court also set to rest the contradictory rulings by
Authority for Advance Rulings (AAR) in the case of the Citrix Systems Asia Pacific Pty. Ltd.[12] on the issue.
The Hon’ble Supreme Court of India
clubbed all the appeals together.
BENCH: Hon’ble Justices Rohinton Fali Nariman, B.R. Gavai, Hrishikesh Roy.
ISSUES INVOLVED IN THE CURRENT CASE
There were two major issues before the Hon’ble Supreme Court:
1. Whether the amount made by the resident Indian buyer for the purchase of
computer software from the foreign software suppliers are in nature of
‘Royalty’ as defined under explanation 2 to Section 9(1)(vi) of the Act and Double Taxation Avoidance
Agreement (DTAA)?
2.
Is
the requirement that the payer should deduct tax at the source on such a
payment, as provided under Section 195 of the Act, applicable?
CONTENTIONS OF APPELLANTS
The resale of computer software
purchased from a foreign supplier or manufacturer by a resident Indian
distributor is merely the sale of goods. The imperative point to be kept in
mind is that even the end user is only granted a limited licence for
self-utilization of the computer software.
The derivative products of the
Copyright are not included in the definition of “Royalties” as provided under
the Doubt Taxation Avoidance Agreement. It is a well-settled fact that the
provisions of the DTAA regulate the taxability of income because they are
inclined toward the assessment. Likewise, the OECD Model Tax Convention on
Income and Capital, the UN Model, and the United States Internal Revenue Code,
among other things, are of similar opinion to the DATT in not considering the
sale of copyrighted material to be royalty.
It has been argued by the learned
Senior Advocate Shri Preetesh Kapur that it is clear that only the goods have
been passed on to the importer and not the copyright in the goods has been
passed on. This is clarified by the language of Section 14(b)(ii) of the
Copyright Act, 1957[13]
by the statutory application of the doctrine of first sale/principle of
exhaustion.
It is humbly submitted by Shri Arvind
Datar, learned Senior Advocate appearing on behalf of one of the assesse that
the retrospective amendment which added explanation 4 to Section 9 (1)(vi) of
the Income Tax Act,1961[14]
done by virtue of Finance Act, 2021 which expanded its ambit with effect from
01.06.1976, will not be applicable to the DTAA, as the expanded definition of
royalty did not exist at that time of application to an assessment year. He
further cited the case of Union of India v. Azadi Bachao Andolan,[15]
and argued that the DTAA would prevail over the domestic law as it is more
advantageous to the deductor tax to an extent under Section 195 of the Income
Tax, Act. He humbly concluded by stating that there is no need for any tax
deduction to be done by the Indian imported under 195(1) of the Income Tax Act.[16]
CONTENTIONS OF RESPONDENTS
The Additional Solicitor general
appearing on behalf of the Revenue argued that the DTAAs is not applicable to
the persons mentioned in Section 195 of the Income Tax Act[17]
if they are not in fact assesses because of the fact that when provisions of
DTAAs read along with Section 90 of the Income Tax is applicable only to
persons who could be described as assessees.
Further, he relied on AP Transco[18]
case which provides a clear-cut distinction that a payer under Section 195 of
the act and an assessee under Section 2(7) of the Income Tax, Act[19]
are different.
He also relied heavily on a recent
judgement of the Supreme Court of India, given in the case of PILCOM v. The
Commissioner of Income Tax[20]
(PILCOM), which laid down that tax has to be deducted at source irrespective of
whether tax is otherwise payable by the non-resident assessee. He also stated
that tax concessions are not available in relation to payments with respect to
software imported separately or independently of computer hardware, which was
clarified by CBDT Circular No. 588 dated 02.01.1991.
The Additional Solicitor General
humbly argued that copyright is parted from the original owner since adaptation
of software is possible, admittedly for installation and use on a particular
computer. He further relied upon Section 52(1) (ad) of the Copyright Act,1957[21],
that making copies or adaptation of computer programmer from a legally obtained
copy for non-commercial, personal use does not amount to infringement and as a
consequence per contra would amount to infringement if copies or adaptation are
made for commercial use.
He also argued that the doctrine of
first sale/principle of exhaustion has no application as it is not statutorily
recognised in Section 14(b)(ii) of the Copyright Act,1957[22],
There is parting of a right or interest in copyright by the distributors of
copyright software license or sell such computer software to end-users and as a
consequence would be hit by Section 14(b)(ii) of the Copyright Act.
The principle laid down in the
judgement of Tata Consultancy Services v. State of Andhra Pradesh[23]
which states that software recorded on compact discs are goods. This principle
was laid down in the context of sales law tax and is therefore not applicable
to the Act.
JUDGEMENT:
After hearing the arguments for both
sides, the Hon’ble Supreme Court of India ruled that software firms that
purchase computer software from foreign software suppliers/manufacturers have
now been exempted from deducting the TDS. As a consequence of this ruling, the
cost of purchasing computer software by Indian firms/end-users will be lower
because foreign suppliers/manufacturers may choose to lower the price due to
the tax relief provided by the judgment. This effect will be of great benefit
to Indian suppliers/end-users.
The Hon’ble Supreme Court further
clarified while citing the definition of royalties provided in Article 12 of
the Double Taxation Avoidance Agreements that persons mentioned under Section 195
of the Income Tax Act have no obligation to deduct tax at source because the
distribution agreement/EULAs in these cases do not create any interest or
rights in such distributors/end-users, which would amount to the use of or the
right to use any copyright.
The Court also stated that the
expanded definition of royalty under Section 9(1)(vi) of the Act, which was
done through the Finance Act, 2012, is not clarificatory in nature, and
withholding cannot be bound on the payer due to a substantive legislative
change that did not subsist at the time of payment by the payer. The amendment
done through the Finance Act, 2012, had a retrospective effect from 01.04.1976.
Thus, the Act’s Explanations 4–9(1)(vi) cannot be applied
retrospectively.
The application of provisions
contained in the Double Taxation Avoidance Agreements can only be done to the
degree that they are more beneficial to the assessee.
Furthermore, the
Hon’ble Supreme Court has also laid down that adapting a computer program or
generating copies to use it for the purpose it was purchased for and delivered,
or even making backup copies, will not constitute an infringement of copyright and do not amount to parting with copyright, according to
modified Sections 14(b)(ii) and 52(1) (aa). It has also been laid down that
EULAs must be read as a whole to determine the true nature of the transaction.
The Court
also stated that, if a non-resident is in a compelled to pay tax under Section
9 read with Section 4 of the Act and along with the Double
Taxation Avoidance Agreements, then only a tax deduction at source can be
allowed under Section 195 of the Act.
Consequently, the judgement of the Supreme Court of India in the case
of PILCOM v. Commissioner of Income Tax[24],
which laid down that tax has to be deducted at source irrespective of whether
tax is otherwise payable by the non-resident assessee, is not applicable.
After stating the above findings, the
Supreme Court ruled in favor of the assessees in all four categories provided
and upheld the ruling of the High Court of Delhi. The Court has determined that
the amounts remunerated by the resident end-users/distributors to non-resident
computer software suppliers/manufacturers are not royalty payments for the use
of copyright in the software.
Therefore, they do not result in any
income taxable in India, thereby excluding the people referred to in Section
195 of the Income Tax Act,1961.
CRITICAL ANALYSIS OF THE JUDGEMENT
a) Payment: For the transfer or use of
copyright:
A copyright provides an exclusive
right to do or to authorize to do certain acts in respect of a “work.” It also
includes an exclusive right to reproduce the work in any
material form and exploit it by way of sale, transfer, license, etc. Furthermore,
the production of copies or adaptation of computer programs to utilize or to
make up back-up copies as a temporary protection against loss, destruction, or
damage in order to utilize it does not amount to an act of infringement of
copyright. Even the storage of the same would not be considered an infringement
of copyright.
For the purposes of the Indian Copyright Act,1957 a computer program,
that is, computer software, qualifies as a literary work. The owner of the
copyright is allowed to grant any interest in his rights by granting a license
in return for a royalty payment. When such a license is granted, only the use
of the rights contrary to the license granted would amount to the infringement
of copyright under the ICA.
After analyzing the meaning of the term royalty under the Act and
relevant tax treaties along with various decisions of the Court, the Hon’ble
derived the following conclusions:
·
Copyright is an exclusive right that
gives the right to restrict others from performing certain acts. This is also negative
in nature. Copyright is an intangible and incorporeal right in the nature of a
privilege. The ownership of physical materials is quite different from the
ownership of copyright in a work.
·
The transfer of ownership of the
physical thing in which the copyright exists provides the purchaser the right
to do with it whatever may please them. However, the only exception is that
they do not receive the right to reproduce and issue the same to the public,
unless such copies are already in circulation and other acts are provided in Section
14 of the Copyright Act, 1957.
·
Copyright is not parted when the core
of the transaction is to provide the end-user access to and make use of the
“licensed” computer software product over which the licensee has no exclusive
rights; consequently, no infringement takes place, as endorsed by Section 52 of
the Copyright Act, 1957.
·
When the license granted is
non-exclusive and non-transferable, it cannot be construed as a licence to
enjoy all or any of the enumerated rights mentioned in Section 14 of the
Copyright Act, as it merely enables the use of a copyrighted product.
Clauses of the agreement states do not matter, and only the real nature
of the transaction with regard to the overall terms of the agreement and the
surrounding circumstances is relevant.
In the present case, the meanings of some of the terms of the sample
agreement with the distributor and end users of the software are as follows:
·
A non-exclusive, non-transferable
license to resell computer software to end users was granted to the
distributors.
·
Distributors were not granted the
right to use software.
·
The non-transference of copyright to
the distributor or to the ultimate end user is specifically stated in the
agreement.
·
Distributors and end users were
restricted from sub-licensing, transferring, reverse engineering, modifying, or
reproducing software. Only the use of a computer program was granted to end
users.
The sale of a physical object that contains an embedded computer program
is "licensed" by the non-resident supplier to the distributor and
resold to the resident end user or directly supplied to the resident end user. Such
sale of goods does not involve the transfer of copyright to the software. This
relied on the Supreme Court’s judgment in the case of Tata Consultancy
Services.[25]
b)
Meaning of royalty: More
beneficial
The definition of the term royalty is exhaustively provided under Tax
Treaties which mean payment made for the use or right to use any copyright in a
literary work, but the meaning of the aforementioned term under the Act is
different which is also wider than the Tax Treaty inasmuch as transfer of all
or any rights includes granting of a license, in respect of any copyright of
any literary work
A grant of license does not qualify as royalty under the tax treaty when
such a license granted to distributors and end users does not create any
interest or right in the software; thus, grant of such license would not amount
to the "use of or right to use" of copyright.
The phrase “in respect of” used in the Act means “in” or “attributable
to”, which was observed by the Hon’ble Supreme Court. It is an essential
prerequisite that there must be transfer of all or any rights in a copyright by
way of license or otherwise, in order to qualify as royalty even under the Act.
In view of this fact, when the
license granted to the distributors and end users does not involve granting of
any interest in the rights of an owner of a copyright, payment made for such license
will not qualify as royalty either under the Act (up to 2012) or the Tax
Treaty.
The expanded definition
of royalty under Section 9(1)(vi) of the Act, which was done through the Finance
Act, 2012, is not clarificatory in nature, and withholding cannot be bound on
the payer due to a substantive legislative change that did not subsist at the
time of payment by the payer. The provisions of the Act would not be applicable
because the definitions of royalties under the tax treaty are narrower and more
beneficial. Thus, there is no obligation to withhold taxes under Section 195 of
the Act.
The revenue strived to rely on
the decision of the Supreme Court in case of PILCOM[26]
which dealt with Section 194E of Act for the proposition that tax has to be
deducted at source irrespective of whether tax is otherwise payable by the
non-resident assessee.
The Hon’ble Supreme Court
observed that the end results would be absurd if it accepted the contention
since it would be necessary to withhold taxes even where income is not
chargeable to tax in India, which is not the intention of the legislature. As a
consequence, the said decision has no applicability to this case wherein
withholding tac obligations are to be determined in terms of Section 195 of the
Income Tax Act.
c)
Impossibility of withholding tax
obligations.
The definition of “royalty”
under the Act has been expanded by the insertion of Explanation 4 into Section
9(1)(vi) accomplished by the Finance Act, 2012 (with retrospective effect from
June 1, 1976). The alleged disobedience of the law is excused when there is a
disability that makes it impossible to obey it.[27]
A person who has made payments
prior to 2012 cannot be logically expected to apply the expanded definition of
royalty, which was not in existence at the time of making payments to determine
withholding obligations under Section 195 of the Act. Thus, the substantive
amendment to the Act does not compel a person to do something impossible.
d)
India’s Position on the OECD
Commentary and Relevance of OECD Commentaries
When the reservations expressed
by the Indian Government on the OECD commentary dealing with royalty, unless
the reservations were incorporated into the treaties through bilateral
negotiations with the respective countries, such reservations would not affect
its relevance.
The definition of “royalty”
provided in the Tax Treaties and OECD Model Convention are similar. Ergo,
importance may be given to the OECD Commentary as well because making a copy or
adaptation of a computer program to enable the use of the software for which it
was supplied is not considered royalty. This also supports that the payment
made by distributors and end users does not qualify as a royalty. The
aforementioned decree may also be applied to payments made for the subscription
of databases or for satellite bandwidth charges and furthermore assist
taxpayers in ongoing disputes.
REVERSING THE JUDGEMENT
The judgement in the present case
could be overruled by the Supreme Court of India if it upholds the substantive
legislative change done by amending the Income Tax Act, by passing the Finance
Act, 2012, and giving effect to its retrospective part. The present judgement
can be overruled by the Supreme Court of India if it applies its own judgement
provided in the case of the PILCOM v. Commissioner of Income Tax.[28] (PILCOM),
and declare that tax has to be deducted at the source, irrespective of whether
tax is otherwise payable by the non-resident assessee.
[1] Article 12(3) of the Double Taxation Avoidance Agreement between
India and USA.
[2] Section 9(1)(vi)(b) Explanation 4,
The Income Tax Act, 1961, No. 43, Acts of Parliament, 1961 (India).
[3] The Income Tax Act, 1961, No. 43,
Acts of Parliament, 1961 (India).
[4] (2021) SCC OnLine SC 159.
[5] Supra, note 3 at 2.
[6] Ibid.
[7] Ibid.
[8] Ibid.
[9] (2011) 245 CTR (Kar) 481.
[10] ITA
Nos. 264-266/Bang/2002.
[13] The Copyright Act, 1957, No. 14,
Acts of Parliament, 1957 (India).
[14] The Income Tax Act, 1961, No. 43,
Acts of Parliament, 1961 (India).
[15] (2004) 10 SCC 1.
[16] The Income Tax Act, 1961, No. 43,
Acts of Parliament, 1961 (India).
[17] The Income Tax Act, 1961, No. 43,
Acts of Parliament, 1961 (India).
[18] Transmission Corpn. of A.P. Ltd.
v. CIT, (1999) 7 SCC 266.
[19] The Income Tax Act, 1961, No. 43,
Acts of Parliament, 1961 (India).
[20] (2020) SCC OnLine SC 426.
[21] The Copyright Act, 1957, No. 14,
Acts of Parliament, 1957 (India).
[22] The Copyright Act, 1957, No. 14,
Acts of Parliament, 1957 (India).
[23] (2005) (1) SCC 308
[24] (2020) SCC OnLine SC 426.
[26] PILCOM v. Commissioner of Income
Tax, (2020) SCC OnLine SC 426.
[28] (2020) SCC OnLine SC 426.