Facts

• Indian residents imported computer software from non-resident suppliers/ original equipment manufacturers (OEM) for end-use or distribution/ reselling.
• The tax officer (TO) held that on purchase of computer software, the copyright in such software also transfers, and therefore, the corresponding payments have to be taxed as royalty. Accordingly, the Indian importer was obligated to deduct TAS. 
• Various taxpayers and the Revenue filed multiple appeals² before the Supreme Court on the taxability of income arising from the sale/ licence of computer software in the hands of the non-resident supplier/ OEM and the consequential liability of the Indian importers to deduct TAS while making payment for computer software.
• The Supreme Court grouped the appeals into four categories, as follows: 
  • A resident end-user purchases computer software from a non-resident supplier or OEM.
  • Resident Indian companies (acting as distributors or resellers) purchasing computer software from non-resident suppliers or OEMs for reselling it to resident Indian end-users.
  • A non-resident distributor purchases software from a non-resident seller and resells it to resident Indian distributors or end-users.
  • Non-resident suppliers affix distributors or end-users.

Taxpayer’s contentions 

• For Category B cases, the taxpayers contended that the Indian importer is a non-exclusive distributor, which purchases off-the-shelf copies of shrink-wrapped computer software from a non-resident for onward sale to Indian end-users under a Remarketer Agreement. The Indian importer is not a party to the End User Licence Agreement (EULA) and does not have any right, title, interest in the copyright of a non-resident seller. Even the end-user in India only receives a limited licence to use the product itself, with no right to sub-licence, make copies, etc.
• Computer software imported for onward sale constitutes ‘goods’, as per the Supreme Court’s judgment in Tata Consultancy Services³ and that the definition of royalties did not extend to the derivate products of the copyright, viz. book or a music CD, being referred as copyrighted articles.
• The difference between a copyright and a copyrighted article has been recognised under the OECD’s commentary on model tax convention, and therefore, copyrighted article (software) related payments made by Indian importers cannot be characterised as royalty, under the computer software onto hardware and sell it as an integrated unit/ equipment to resident Indian provisions of a DTAA’s based on the OECD’s model convention. The provisions of a DTAA would prevail over domestic tax laws to the extent they are beneficial to a taxpayer.⁴ Therefore, Indian importers were not obligated to deduct TAS from such software payments. 
• The doctrine of first sale was cemented in section 14(b)(ii) of the Copyright Act, 1957 (CA), making it clear that the distribution right of non-resident suppliers would not extend to the sales of copies of work to other persons beyond the first sale.
• In terms of Category A, C and D it was additionally argued that the Central Board of Direct Taxes (CBDT) Circular⁵  addresses ‘remittance for royalties’ and ‘remittance for supply of articles or…computer software’, as separate and distinct payments. The former attracts the ‘royalty’ provision under Article 12 of the DTAA, and the latter is taxable as business profits under Article 7 of the DTAA.
• Mere nomenclature, such as the use of the term ‘licence’, was not conclusive about the character of a transaction.
• Making of copies only to utilise the product to the extent permitted by the EULA, would not constitute an infringement of copyright, as expressly stated in provision of section 52(1)(aa) of the CA.
• Retrospective amendment to section 9(1)(vi) of the Act vide the Finance Act 2012, which expanded the ambit of royalty with effect from 1 June 1976, could not be applied to the years prior to 2012 considering the legal principle that the law cannot compel one to do the impossible, namely, to deduct TAS under an expanded definition of royalty, which did not exist at the time of the payment/ deduction of TAS.

Revenue’s contentions

• Explanation 4 to section 9(1)(vi) of the Act is clarificatory in nature with respect to the position in law right from 1 June 1976, when section 9(1)(vi) of the Act was first brought into force.
• The provisions for tax deducted at source (TDS) are distinct from and exist apart from the provisions for assessment under the Act. Hence, the DTAA’s would not apply to the persons referred to in section 195 of the Act who are not taxpayers, as the provisions of the DTAA’s, when read with section 90 of the Act, are applied only to persons who could be described as taxpayer. In this regard, reliance was also placed in Article 30 of the India-USA DTAA.
• As per the Supreme Court’s decision in Pilcom⁶, TAS is to be deduced irrespective of whether tax is otherwise payable by the non-resident taxpayer.
• A copyright is also transferred at the time of transfer of computer software,⁷ as the end-user can adapt the software (although for installation and use on a particular computer). In such a case, the original owner parts with the copyright. 
• Indian Government had expressed its reservations on the OECD Commentary, especially on those parts of Commentary that deal with parting of copyright and royalty.

Supreme Court’s decision

TAS obligations under the Act/ DTAA

• Deduction of TAS is to be made only if the non-resident is liable to pay tax under the charging provisions contained in section 9 read with section 4 of the Act read with the relevant DTAA.⁸  
• The Supreme Court’s decision in Pilcom⁶, was distinguished based on the fact that section 194E of the Act does not have any reference to the chargeability of tax under the Act by the concerned non-resident taxpayer. On the contrary, a primary requirement of section 195 of the Act is that the deduction can only be made if the non-resident taxpayer is liable to pay tax under the provisions of the Act, in the first place. 
• Article 30 of the India-USA DTAA is connected with the USA municipal taxation laws. It has nothing to do with Indian municipal law governing the liability of persons to deduct TAS under section 195 of the Act; therefore, the Supreme Court declined to entertain the Revenue’s argument that the provisions of the DTAA cannot be considered while determining the TAS obligations of Indian importers. 

Ambit of royalty under the DTAA

• The Supreme Court, relying on the CBDT circular⁹ read with Article 3(2) of the DTAA and Explanation 4 to section 90 of the Act held that where the term ‘royalty’ has been defined under the DTAA, it may be construed in accordance with the meaning assigned to it under the relevant article of the DTAA. 
• Article 12(3) of the India-Singapore DTAA¹⁰ provides for the exhaustive definition of the term ‘royalties’, and refers to payments of any kind that are received as consideration for the ‘use of or the right to use any copyright in a literary work’. 
• As the term ‘copyright’ is not defined under the DTAA or the Act, reference will have to be made to the Indian CA, to understand the meaning of the said term.¹¹  

Copyright v. copyrighted article

• On analysing the various clauses of the EULA(s) executed by taxpayers, the rulings pronounced by the Authority for Advance Rulings and the High Courts, and the provisions of the CA, the Supreme Court drew the following conclusions:
  • Copyright is an exclusive right and intangible and incorporeal right, which is negative in nature, being a right to restrict others from doing certain acts.
  • The terms of the EULA make it clear that the Indian importers did not acquire any copyright and/ or the right to sub-licence, transfer, reproduce, etc. the software and instead acquired non-exclusive, non-transferable license to use the software.
  • A non-exclusive, non-transferable licence, merely enabling the use of a copyrighted product, is in the nature of restrictive conditions, which cannot be construed as a licence to enjoy all of the rights mentioned in section 14 of the CA, or create any interest in any such rights to attract section 30 of the CA.
  • Right to reproduce a computer programme and exploit the reproduction by sale, transfer, licence, etc., is at the heart of an exclusive right/ copyright.
  • The real nature of the transaction must be examined upon reading the agreement as a whole. What is termed a ‘licenced’, is in fact the sale of a physical object that contains an embedded computer programme, and is therefore, a sale of goods.
  • On the doctrine of first sale/ principle of exhaustion, it was held that the object of section 14(b)(ii) of the CA is not to interdict the sale of computer software that is ‘licenced’ to be sold by a distributor, but to prevent copies of computer software once sold being reproduced and then transferred by sale or otherwise. Hence, any sale by the author of a computer software to a distributor for onward sale to end-user, cannot possibly attract section 14(b)(ii) of the CA, as it only applies to cases where copies are made for onward sales.
  • Making copies or adapting a computer programme to utilise this computer programme for the purpose for which it was supplied, or to make back-up copies as a temporary protection against loss, destruction or damage to utilise the computer programme for the purpose for which it was supplied, does not constitute an act of infringement of copyright.
• The Supreme Court relied on the CBDT circular¹² under which ‘remittance for royalties’ and ‘remittance for supply of articles or…computer software’ were addressed as separate and distinct payments to recognise the difference between the payment for computer software licence and other royalty payments.¹³ 

Royalty under the Act

• The Supreme Court also noted that the definition contained in Explanation 2 to section 9(1)(vi) of the Act, is wider in at least three respects:
  • i. ‘Consideration’ also includes a lumpsum consideration that would not amount to income of the recipient chargeable under the head ‘capital gains’;
  • ii. Transfer of ‘all or any rights’, including the granting of a licence; and
  • iii.Transfer must be ‘in respect of’ any copyright of any literary work.
• However, even where the transfer is ‘in respect of’ copyright, the transfer of all or any rights in relation to copyright, as referred in sections 14(a) or 14(b) of the CA, is a pre-requisite. To this extent, there will be no difference in the position between the definition of royalties provided under the DTAA and the Act.

Miscellaneous observation by the Supreme Court 

Relevance of OECD’s commentary

• The Supreme Court appreciated the persuasive value of the OECD Commentary to interpret the international DTAAs and observed that the language of India’s reservations on Article 12 (i.e. ‘reserved the right to’ or ‘may’) is not clear. On the contrary, the Supreme Court highlighted the definite, absolute and clear positions taken by India with respect to the other Articles, wherein the language used is ‘India does not agree…’.
• Further, unless the DTAAs are actually amended by bilateral re-negotiation, the mere expression of reservations would not alter the DTAA provisions. The Supreme Court referred to instances where some DTAAs were bilaterally amended in the recent past; however, provisions relating to royalty remained un-amended despite the reservations made by India on the interpretations under the OECD Commentary.

Conclusion

• The definition of royalty under Article 12 of the DTAA’s, being more beneficial, would take precedence over the definition considered under the Act.
• Payments made for computer software are not covered under Article 12 of the DTAA’s, as the distribution agreement/ EULA(s) in the facts of these cases do not create any interest or right for such distributor/ end-user, which would amount to ‘use of’ or ‘right to use’ any copyright for all four categories of appeals considered by the Supreme Court.
• Therefore, Indian importers do not have an obligation to deduct TAS from the amounts paid to the non-resident suppliers/ OEMs, as consideration for purchase of computer software.

PwC comments

• The Supreme Court held that software payments, where no right or interest is created in favour of the distributor/ end-user for the ‘use of’ or ‘right to use’ any copyright, cannot be regarded as royalties under the DTAAs.
• This is an important judgement providing much needed respite from age-old litigation pertaining to taxation of software payments in India.

¹ Civil Appeal Nos. 8733-8734 of 2018

² A common Supreme Court order has disposed of a batch of appeals from various High Courts and an Advance Ruling.

³ Tata Consultancy Services v. State of A.P. [2005] (1) SCC 308

⁴ Reliance was placed on Union of India v. Azadi Bachao Andolan [2004] 10 SCC 1

⁵ No. 10/ 2002 dated 9 October 2002

⁶ Pilcom v. CIT, West Bengal VII [2020] SCC Online SC 426

⁷ Citrix Systems Asia Pacific Pty Limited, In Re. [2012] 343 ITR 1 (AAR)

⁸ Reliance was placed on the CBDT Circular No. 728 dated 30 October 1995 and the rulings pronounced in the case of GE India Technology Centre (P) Limited v. CIT [2010] 10 SCC 29 and Vodafone International Holdings BV v. Union of India [2012] 6 SCC 613.

⁹ CBDT Circular No. 333 dated 2 April 1982

¹⁰ The Supreme Court has considered the definition as per the India-Singapore DTAA for reproducing the definition of the term ‘royalty’, while enumerating various other DTAAs, as the language of all the DTAAs are based on the OECD Model Tax Convention on Income and Capital, and therefore, are substantially similar.

¹¹ Reference made to section 16 of the CA, which states that “no person shall be entitled to copyright…otherwise than under and in accordance with the provisions of this Act or of any other law for the time being in force”.

¹² CBDT Circular No. 10/ 2002 dated 9 October 2002

¹³ Reliance was also placed on the decision of State Bank of India v. Collector of Customs [2000] 1 SCC 727

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