tax alert reliance infocom

7/29/2019 Tax Alert Reliance Infocom

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EY Tax AlertMumbai Tribunal, following Karnataka High Court, characterizespayment for computer software as royalty

11 September 2013

T ax A lerts cover

significant tax news,

developments and

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Executive summary

This Tax A lert summari zes a recent ruling of the Mumbai I ncome Tax A ppellate

Tri bunal ( Tribunal) in the case of Reliance Infocom Ltd. ( Taxpayer) [ 1]on the issue

of whether consideration for software would be in the nature of royalty under

the Indian Tax Laws ( IT L) and the applicable Double Taxati on Avoidance

A greements (DTA As) [2 ] . The Taxpayer, an Indian telecom company, had

purchased wireless network equipment f rom vari ous vendors. I t had also entered

into stand-alone agreements with the same vendor and other foreign companies

( FCos) for software speci fic to the equipment supplied.. O n facts, the Tri bunal

held that the payment for software license under a stand-alone agreement ( i .e. ,

which is not integral to the equipment purchase) is considerat ion for transfer/use

of copyright and is taxable as royalty, both under the ITL and the relevant

DTAAs.

[ 1]DD IT( IT ) v. Reliance Infocom Ltd. ( now known as Reliance Communications Ltd.) [ TS-433-ITA T-2013( M um)]

Various group companies of Reliance and Lucent Technologies GR L L LC , USA were the other r espondents[2]

Indias DTA As with USA, Israel, China, Sweden, Singapore, Japan, Australia, Canada, U K and Netherlands


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Background and facts

Royalty is defined in the IT L to mean

consideration for the transfer of all or

any rights ( including the granting of a

license) in respect of any copyright. T he

definiti on of royalty under the IT L was

amended by Finance Act, 2012 to clarify

that the transfer of all or any rights in

respect of any right, property or

information includes right for use/to use

computer software (i ncluding the

granting of a li cense), regardless of t he

medium through which such right is

transferred. The comparable definit ion

under various DTA A s define royalty to

mean consideration for the use of, or the

right to use, any copyright of a literary,

arti stic or scienti fic work.

In order to establish wireless

telecommunications network in India, the

Taxpayer, entered into a contract with

an Indian company (ICo) for supply of

hardware, software and servi ces for

establishing the network. The software

supply contract was thereafter assigned

by ICo to its Foreign Group Company

(FCo) under a tripartite agreement

between the Taxpayer, FCo and ICo. FCo

supplied software under this agreement.

The Taxpayer also entered into similar

software supply contracts with other

FCos.

The Taxpayer applied to the Tax

A uthority for a nil withholding tax order

on the payments. The Tax A uthority

considered the payments as royalty and,

hence, taxable for the recipient.

O n appeal by the Taxpayer, the First

A ppellate A uthority observed that the

Taxpayer was forbidden to decompile,

reverse engineer, disassemble, decode,

modi fy or sub-license the software, asper the agreements. A lso, the agreement

provided for returning the software to

FCo after the termination/cancellati on of

the agreement. Based on these facts, the

First A ppellate Authority held that the

Indian Copyright Act (was inapplicable

and, as the Taxpayer only had a copy of

software without any part of copyright

of the software , the payments did not

amount to royalty under the DTA A s.

Aggri eved, the Tax Authority appealed

before the Tr ibunal. T he Taxpayer

contended that the mai n purpose of

entering i nto vari ous contracts was for

setting up a mobile network and that the

software did not work without the

equipment. T he Taxpayer argued that theequipment-specific software was nothing

but a computer technology that would

result in network communication when

used with the equipment.

Tribunals ruling

On taxation of software as royalty

The Tribunal noted that the disti nction

between copyri ghted art icle and

copyright , as brought out by the

Special Bench of the Delhi Tribunal [3 ] (SB)

and approved by the Delhi High Court

(HC) [4 ] , was that the purchase of

software along with hardware is purchase

of copyrighted arti cle and no

copyri ght was involved. But, in these

decisions, the software was supplied

along with hardware as part of the

equipment and there was no separate

sale of software. Software was an

integral part of the supply of equipment

for telecommunications, generally called

embedded software.

Though the Tribunal agreed with the

Delhi H C decisions in the cases of

Nokia[ 5] and Erickson[6 ] on principles, it

distinguished them on facts. The Tribunal

held that the Delhi HC decisions were in

the case of supply of software along with

hardware as an embedded software,

whereas, in the present case, the

Taxpayer purchased the software by

virtue of a stand-alone software li cense

agreement . T he software was neither an

integral part of purchase of equipment

nor was it embedded software. The

delivery was separate, in the form of

CD s, mostly abroad and was installed in

India separately.

[ 3]Motorola Inc. [ (2005) 270 ITR (AT ) 62]

[ 4]Erickson [343 ITR 370] and Nokia Networks [25 taxmann.com

225][ 5]

Refer EY Tax A lert dated 14 September 2012

[6 ]Refer EY Tax Alert dated 28 D ecember 2011


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The Tribunal held that FCo transferred a

license to use it s copyright to the

Taxpayer where FCo continued to be the

owner of the copyright and all other

IPRs. The Tribunal further held that

copyri ght is an umbrella of many

rights. The licence granted for mak ing

use of the copyright in respect ofshrink-wrapped software/off-the-shelf

software, authori zing the end user to

make use of its own network equipment,

would also amount to transfer of part of

the copyright. Consequently, this would

amount to transfer of right to use the

copyri ght for internal business.

The Tribunal specifically dealt in detail

with the Karnataka HC decisions in the

cases of Samsung [345 I TR 494 ( K ar) [ 7]

and Synopsis International [212 Taxman

454 (K ar)] . The Tribunal observed that

the facts in the present case were simi lar

to the ones considered by the Karnataka

HC in the case of Samsung wherein i t

was held that the end users of the

computer program were granted a

copyri ght where they were granted a

license to make copies of the computer

program for back-up or archival

purposes. Reliance was also placed on

another K arnataka HC decision in the

case of FCos group company, Lucent

Technologies [348 I TR 196 ( Kar) [8] ,

wherein, under similar facts as in the

present case, i t was held that paymentfor purchase of copy of a computer

program that was supplied as a bundled

contract, along with hardware on which

the computer program was to be

installed, was taxable as royalty. In l ight

of the above decisions, that too in the

case of FCos group company i tself on the

same terms of agreement as that of the

Taxpayer for supply of software, the

Tri bunal followed the decisions of the

Karnataka HC.

Payment made by the Taxpayer to FCo

and various other suppliers was said to

be royalty.

[ 7]Refer EY Tax Alert dated 30 N ovember 2011

[ 8]Refer EY Tax Alert dated 19 December 2011

Comments

This Tribunal ruling adds to the

plethora of rulings that currently

exist on taxation of cross-bordercomputer software transactions.

Characterization of cross-border

software payments, either as royalty

or as business profits, has been a

contentious issue in India.

Characterization as royalty would be

subject to withholding tax, whereas

characterization as business profi ts

would not be taxable in the absence

of a business presence/permanent

establishment of the foreign

enterprise in India. A s the issue is

currently pending before the

Supreme Court (SC), finality may be

reached only once the matter is

decided by the SC. However, this

ruling suggests that, where facts are

similar to the ones considered by

the SB and the Delhi HC (i.e.,

software embedded in the

equipment/hardware) , the payments

could still be protected and would

not be regarded as royalty.


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