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 ITO vs. Vikram A. Pradhan (ITAT Mumbai)

DIRECTOR OF INCOME TAX Vs. INFRASOFT LTD.
January, 06th 2014
      *IN THE HIGH COURT OF DELHI AT NEW DELHI

%                           Judgment reserved on : 3 rd July, 2013
                      Judgment pronounced on:22nd November, 2013

+                            ITA 1034/2009

DIRECTOR OF INCOME TAX                               ..... Appellant

                             Through     Mr. Sanjeev Sabharwal,
                                         Advocate.

                             versus
INFRASOFT LTD.                                  ..... Respondent
                             Through     Mr. Ajay Vohra with Mr.
                                         Somnath Shukla,
                                         Advocates.

CORAM:
HON'BLE MR. JUSTICE SANJIV KHANNA
HON'BLE MR. JUSTICE SANJEEV SACHDEVA

SANJEEV SACHDEVA, J.


1.       This is an appeal under Section 260A of the Income

         Tax Act, 1961 (hereinafter referred to as the "Act")

         filed   by    the    Revenue     impugning     order    dated

         19.12.2008 passed by the Income Tax Appellate

         Tribunal (hereinafter referred to as "ITAT")


2.       Vide    order       dated     20.10.2009,    the    following

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ITA 1034/2009                                                Page 1 of 174
         substantial questions of law were framed:

                 "1)   Whether   the   learned    ITAT   erred        in
                 holding that nature of receipts amounting to
                 Rs. 2,74,00,630/- was business income and not
                 royalty   income    wherein   the     meaning        of
                 Section 9(1)(vi) read (SIC) with Article 12 of
                 Indo-US-DTAA?

                 2)    Whether supply of software on license is
                 royalty/included services within the meaning
                 of Section 9(1)(vi) / Article of Income Tax Act /
                 Indo-USA-DTAA?"

3.     On       03.07.2013,    the   counsel     for   the     respondent

       Assessee submitted that he was not relying upon

       Section 9(1)(vi) of the Income Tax Act and in view of

       the statement made by the counsel, we on 03.07.2013

       held that Explanation 4 to Section 9(1)(vi) of the

       Income Tax Act, 1961 need not be examined and

       applied. Reference was also made to the judgment of

       the Supreme Court in UNION                OF    INDIA   VS .    AZADI

       BACHAO A NDOLAN (2003) 263 ITR 706. In view of what


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ITA 1034/2009                                                    Page 2 of 174
       transpired        on    03.07.2013,        with    respect     to     the

       examination and applicability of Section 4 to Section

       9(1)(vi), the second issue framed on 20.10.2009, does

       not arise for consideration and is thus not dealt with in

       the present judgment. The substantial Question of law

       framed on 20.10.2009 was recast as under:


                "Whether the Income Tax Appellate Tribunal
                was right in holding that the consideration
                received by the respondent Assessee on grant
                of licences for use of software is not royalty
                within the meaning of Article 12(3) to the
                Double        Taxation      Avoidance      Agreement
                between       India   and   the   United    States    of
                America?"

4.     The respondent/Assessee is an international software

       marketing         and      development            company      of      an

       international group. The holding company is based in

       US being Infrasoft Corporation.


5.     The Assessee M/s Infrasoft Ltd. is primarily into the


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ITA 1034/2009                                                        Page 3 of 174
       business         of     developing          and    manufacturing          civil

       engineering software. One such software, which is

       subject matter of the present controversy, is called

       MX. The said MX software is used for civil engineering

       work and for design of highways, railways, airports,

       ports, mines, etc. The said software is used by private

       consultants.


6.     In view of the market position, the Board of the

       Assessee Infrasoft Limited opened a branch office in

       India. The branch in India imports the package in the

       form      of    floppy       disks    or    CDs    depending        on     the

       requirements            of    their   customers.        The   system         is

       delivered to a client/customer. The delivery of the

       system         entails       installation    of   the   system      on     the

       computers          of    the     customers        and   training     of    the

       customers for operation of the system. The branch

       office further undertakes the responsibility of updation

       and operational training apart from providing support

       for      solving      any     software      issues.     The   respondent

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ITA 1034/2009                                                             Page 4 of 174
       Assessee develops customized software to be used by

       the      customers   for   designing    highways,    railways,

       airports, ports, mines, etc. The software so customized

       is then licensed to an Indian customer and the branch

       office of the Assessee in India perform services

       involving     interface    to   peripheral   installation    and

       training etc.


7.     On 28.11.2003, the respondent Assessee vide its

       return of income, declared a loss of Rs.21,75,246/-.

       The same was assessed under Section 143(3) of the

       Act on 31.01.2006. The assessment order was framed

       by the Assessing Officer (hereinafter referred to as the

       "AO")      whereby   the    Assessing    Officer    taxed     the

       receipts on sale of licensing the software as "royalty"

       as per Article 13 (Sic Article 12) of Indo-US Double

       Taxation Avoidance Agreement. Under Section 44D

       read with Section 115A of the Income Tax Act, the

       Assessing Officer brought the aggregate amount of

       Rs.2,85,76,278/-, received by the Assessee during the

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ITA 1034/2009                                                Page 5 of 174
       year under consideration to tax at 20%.


8.     The AO issued a show cause notice to the Assessee

       company requiring them to show cause as to why the

       receipts      shown      by    the   Assessee   company    from

       sale/licensing         of software, having referred to the

       nature of service rendered by the Assessee company,

       should not be taxed as royalty as per Article 13 (Sic

       Article 12) of DTAA and Section 44D read with Section

       115A of the Act.


9.     In reply to the said show cause notice, the Assessee

       company relying on the judgment of the Supreme

       Court in the case of TATA CONSULTANCY SERVICES VS .

       STATE    OF     A NDHRA PRADESH (2004) 271 ITR 401 (SC)

       (BCAJ) (2005) 1 SCC 308 stated that the moment

       copies     of    software      programmes   were    made     and

       marketed,        the    same    become    goods    which   were

       chargeable to sales tax. The Assessee company

       further contended that when the software were goods


=======================================================================

ITA 1034/2009                                                Page 6 of 174
       as held by the Supreme Court in the said case, the

       Assessee company would be entitle to deduction of

       purchase cost of software as well as other expenses

       incurred and the net profit alone could be taxed as

       business profit as per Article 7 of DTAA between USA

       and India. The Assessee company further objected to

       the show cause notice contending alternatively that

       even if the receipts were to be treated as royalties or

       even for technical services, the same having arisen

       through a permanent establishment in India, it was

       chargeable to tax as business profit as per the said

       Article 7 of DTAA. The Assessee further contended

       before the AO that Section 44D inserted by Finance

       Act, 2003 w.e.f 01.04.2004, making all the expenditure

       incurred   for   earning   royalty   or   fee   for   technical

       services allowable, was liable to be given retrospective

       application to the case of the            Assessee for the

       Assessment Year 2003-04 as that was the legislative

       intent behind insertion of the said provision.


=======================================================================

ITA 1034/2009                                                Page 7 of 174
10.    The AO rejected the contention of the Assessee

       company. With respect to the decision of the Supreme

       Court in TATA Consultancy Services (supra), the

       AO distinguished the said judgment holding that the

       same had been rendered in the context of the Sales

       Tax Act and was applicable in terms of the definition of

       "goods" as given in the Sales Tax Act and was in the

       context of deciding whether the software recorded on

       the      computer   disk   was   covered   within   the   said

       definition of goods or not. In the context of the facts of

       the case as per the AO, the said judgment was not

       applicable.


11.    With regard to the definition of royalty as given in

       Section 9 (1) (vi) of the Act as well as Article 12 of the

       DTAA, the AO came to the conclusion that the amount

       received      by     the    Assessee       company        from

       sales/licensing of the software was royalty in terms of

       the said definition. The reasoning of the AO to arrive

       at this conclusion is as under:-

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ITA 1034/2009                                              Page 8 of 174
                "(i)     The software is licensed not sold. The
                copyright of the software remains with the
                Assessee       however       it    allows    the   use    of
                copyright to the person making payment to it.
                As per the Indian Copyright Act 1957 as
                amended in 1994 software are entitled to
                copyright protection. The Assessee possesses
                Copyright in the software, which it can enforce
                in India if any violation of such right is notices
                by     it.   Further   the        Indian    Copyright    Act
                recognizes `copyright' as doing or authorizing
                the doing of any of the following acts in respect
                of a work or any substantial part thereof
                namely, - in case of a computer programme to
                sell or give on commercial rental or offer for
                sale or for commercial rental any copy of the
                computer program. It is therefore clear that
                the Assessee has authorized to use of the
                copyright of the customer in India.

                (ii)     The software owned by the Assessee is
                patented software. Consideration for allowing
                the use of the patented article falls within the
                definition or royalty payment. Even if it is


=======================================================================

ITA 1034/2009                                                            Page 9 of 174
                considered that the software owned has not
                been patent, there is no denial of the fact that
                it is essentially an invention. The development
                of such software requires highly technical
                manpower,        with    highly    sophisticated
                infrastructure and huge investments. Similarly,
                the software can also be considered as a
                scientific work. Therefore, the software can
                also be said to be information developed out of
                scientific experience.

                (iii)   The payment is also qualified for the use
                of secret formula or process. The software
                developed by Infrasoft when installed in a
                computer responds to every instruction in a
                specific way. It recognizes the command and as
                per its programming yields the desired result
                and reflects the same on the output devices.
                This argument is further strengthen from the
                fact that cost of the medium viz. computer
                discs, floppy etc., on which the program is
                written is negligible as compared to the overall
                price of software. Had it not been a secret
                programming, anybody could have written


=======================================================================

ITA 1034/2009                                               Page 10 of 174
                these types of programs and sold it at a very
                low price as compared to the price of the
                original software.

                (iv)    The software developed by infrasoft is
                customizing     software    which    are   used    for
                specific purposes like design of highways,
                railways, airport, port, mines etc. This software
                are purchased by private consultant or end
                users and they further exploits for commercial
                purposes. This clearly falls under definition of
                `royalty'."

12.    In view of the above reasoning, the AO treated the

       entire amount received by the Assessee Company for

       transfer        of   software   as   well    as   other    incidental

       services towards installation of software, imparting of

       training etc. in the nature of royalty. He further held

       that since the royalty income had accrued/arisen to the

       Assessee Company through its PE in the form of

       branch office in India, the same was chargeable to tax

       in India as per Article 13 (vi) (Sic Article 12 (vi))of the


=======================================================================

ITA 1034/2009                                                     Page 11 of 174
       DTAA. He held that though the royalty income was

       liable to be taxed as business profit under Article 7 of

       DTAA, the expenses incurred for earning the said

       income were to be allowed as per domestic law and as

       per him, since Section 44D was applicable to the

       Assessment Year 2003-04 specifically prohibited any

       allowance for such expenditure, the entire amount

       received   by   the   Assessee     as   royalty   was     thus

       chargeable to tax @ 20% of the gross receipts as per

       the provisions of Section 44D read with Section 115A

       of the Act. The AO thus brought the aggregate amount

       of Rs.2,85,76,278/- received by the Assessee during

       the year under consideration to tax @ 20%. The AO

       thus framed the assessment under Section 143(3) vide

       his order dated 31.01.2006.


13.    Aggrieved by the order of the AO, the Assessee filed

       an appeal before the Commissioner of Income Tax

       (Appeals) (hereinafter referred to as the ,,CIT (A)). The






=======================================================================

ITA 1034/2009                                             Page 12 of 174
       main       grounds      raised      by    the   Assessee         company

       against the said order were as under:-


                (i)     The programme software was goods in
                terms of the judgment in the case of TATA
                CONSULTANCY SERVICES (SUPRA);

                (ii)    The payment received by the Assessee
                company was payment for copyrighted article
                and not copyrighted right and thus could not
                be assessed as royalty under Article 13 (Sic
                Article 12) of DTAA;


                (iii)   The provision of DTAA override the
                provision of Income Tax;

                (iv)    The right to use a copyright was totally
                different from the right to use a programme
                embedded in a software;

                (v)     There was no transfer of right in a
                copyrighted article;

                (vi)    The    Assessee         company       carried     on
                business      in   India    through       a    permanent
                establishment and thus Article 13(vi) of the

=======================================================================

ITA 1034/2009                                                           Page 13 of 174
                Indo-UK Convention was not applicable but in
                fact Article 7 was applicable;

                (vii)   Section 115A could not be applied as the
                receipts were not royalty and since the receipts
                were not taxable as royalty and fee for
                technical services, the same could not be
                subjected to tax under Section 44D read with
                Section 115A.

14.    The CIT(A) vide the order dated 10.01.2008, rejected

       the submissions of the Assessee company. The CIT(A)

       in his order noted that the Assessee company was

       engaged in licensing of MX software which is an

       engineering friendly tool for designing all types of road

       projects to Indian customers. He noted the clarification

       on behalf of the Assessee company that the standard

       MX software needed to be customized depending on

       the country-wise, project-wise and customer specific

       requirements and that the software was supplied by

       the Assessee company to customers in India only after

       such customization to include Indian standard of road

=======================================================================

ITA 1034/2009                                               Page 14 of 174
       construction and project specific requirements of the

       Indian customers. On the issue of the Assessee

       company having PE in India in the form of a branch

       office, the CIT(A) noted that there was no dispute that

       the branch office of the Assessee company had been

       opened in terms of the approval granted by the

       Reserve Bank of India and constituted a PE in India.


15.    The      CIT(A)    examined     a   sample        representative

       agreement between the Assessee company and one

       of its Indian customers for software licensing and

       maintenance        to   ascertain   the     exact    nature     and

       character    of    income    received       by    the   Assessee

       company in India on account of supply of software,

       annual     maintenance       charges        and     training     fee

       amounting     to    Rs.2,74,00,630/-,       Rs.9,25,648/-       and

       Rs.2,50,000/-      respectively.    After    referring     to    the

       relevant terms and conditions of the said agreement,

       the CIT(A) came to the conclusion that the Assessee

       company had transferred certain rights to the Indian

=======================================================================

ITA 1034/2009                                                  Page 15 of 174
       customers to use software at certain locations for fixed

       licence fee. The          CIT(A) noted that the amounts

       received by the Assessee company were in lieu of the

       following services rendered by it:

                "(a)    that appellant had transferred certain
                right in respect of copyright of software to
                Indian customers.

                (b)     that appellant had charged `Licence Fee'
                for supply of software as evident from terms
                and conditions of `Licence fee' agreement. It is
                pertinent to mention here that no where under
                the agreement words `sale consideration' were
                used.

                (c)     that appellant had granted licence to
                Indian customer to use the software in lieu of
                the payment.

                (d)     that appellant had also received payment
                in lieu of software maintenance service which
                included    provisions   of   updates   and   user
                support services to customers.



=======================================================================

ITA 1034/2009                                                 Page 16 of 174
                (e)    that appellant had also received payment
                in lieu of training services rendered to Indian
                customers."

16.    The CIT(A) held that what was taxed as royalty was

       the amount received as consideration for the use or

       right to use and not outright purchase of the right to

       use      an    asset.   He   held   that   the   royalty   was     a

       consideration including a lump sum consideration for

       transfer of all or any right (including the granting of a

       licence) in respect of a copyright, patent, trademark,

       design and modal or secret formula etc. According to

       the CIT(A), there are two types of transfers, one is

       transfer of "right in the property" and transfer of "right

       in respect of property".            He held      that these two

       transfers were distinct and had different legal effects.

       In one, right for purchase while in other, no purchase

       is involved. He relied on the decision of the Calcutta

       High Court in the case of CIT VS. D AVY ASHMORE INDIA

       LTD. (1991) 190 ITR 626, wherein it was held that


=======================================================================

ITA 1034/2009                                                 Page 17 of 174
       where a transferee retains the property rights in a

       design, secret formula etc. and allows the use of such

       rights, the consideration received for such user was in

       the nature of royalty and where there is an outright

       sale or purchase, the consideration is for transfer of

       such design, secret formula etc. and could not be

       treated as royalty. The CIT(A) finally held that the

       amount received by the Assessee Company from its

       Indian customers under software licence agreement

       was in the nature of royalty and same was chargeable

       to tax in India as per Explanation 2 to Section 9(1)( vi).

       The      CIT(A)   rejected   the   plea   of   the   Assessee

       company wherein the Assessee company had relied

       on the revised OECD commentary to contend that only

       transfer that enabled a transferee to commercially

       exploit a software copyright gave rise to royalty

       income and as only limited right to use the software

       had been transferred, the amount received for such

       limited use       was   not royalty income.      The     CIT(A)


=======================================================================

ITA 1034/2009                                               Page 18 of 174
       rejected the contention of the Assessee company

       holding that OECD had given a very conservative

       interpretation of the word "used" and the same was not

       applicable in the facts of the case of the Assessee

       company. The CIT(A) noted that the said revised

       OECD commentary on software payment had not been

       accepted    even    by   some    of   the     OECD    member

       countries and was not applicable in India since India

       was not even a member of OECD and specially when

       the Indian High Powered Committee had expressed its

       reservation    in   characterization     of    the    software

       payment in the said country. With regard to the

       reliance of the Assessee company on the judgment of

       the Supreme Court in the case of TATA CONSULTANCY

       SERVICES (SUPRA), the CIT(A) held that though the

       transfer of right to use a good was not sale in its

       traditional sense but the same was held to be sale on

       the expanded definition given in the relevant Sales

       Tax Act, wherein such transfer was treated as deemed


=======================================================================

ITA 1034/2009                                               Page 19 of 174
       sale.     He      held     that   different   statutes   or    different

       phraseologies treat the same transaction differently

       and thus it was not permissible to import the meaning

       assigned in one statute into the different statues.


17.    The CIT(A) rejected the contention of the Assessee

       company and held the receipts to be royalty income

       and concluded as under:-


                "4.8.1          As per provisions of section 9(1)(vi)
                the     royalty     income     should    satisfy     twin
                conditions that there has to be consideration,
                and this consideration should be for transfer of
                all or any right (including the granting of the
                licence) in respect of the copyright, patent,
                invention, design, secret formula or process,
                scientific work. In this case the payment under
                software license agreement has fulfilled both
                the conditions and the income from software
                license was taxable in India as royalty.

                4.8.2           As per provision of section 9 the
                payment made for import of software are


=======================================================================

ITA 1034/2009                                                        Page 20 of 174
                royalty   payment     and   the   only    exception
                provided is in the form of second proviso to
                section 9(1)(vi) of the Act which excludes such
                royalty income from purview of section 9(1)(vi)
                only when the computer software is supplied
                by a non-resident manufacturer along with
                computer or computer based equipment under
                any scheme approved under the policy of
                computer      software       export,       software
                development     and    training    1986        of    the
                Government of India. However, this exception
                is not applicable to the facts of this case where
                appellant had granted software licence to
                various Indian customers.

                4.8.3       The characterization taxability of
                income from import of software has been
                made amply clear in the Income Tax Act
                through    section   115A   of    the    Act    which
                specifically refers to cases where royalties are
                paid to non --resident for the transfer of all or
                any right (including the granting of the license)
                in respect of any computer software to a
                person resident in India.


=======================================================================

ITA 1034/2009                                                       Page 21 of 174
                4.8.4          A copy of software supplied by the
                appellant did not amount to a sale but it is a
                licence to use the software. This is because
                software is an intellectual property right (IPR)
                which can be licensed to one use and can be
                given further to any number of user. In other
                words the IPR in software still remain intact
                with     the   supplier.     Thus   effectively     the
                consideration paid is only for license use. It is
                pertinent to mention here that the Finance Act,
                2004 has inserted Category No.55B to include
                intellectual pro perty services" to mean.

                "(a)    transferring      whether   permanent        or
                otherwise or

                (b)     permitting use or enjoyment of any
                intellectual property right"

                for levy of service tax. This amendment has
                been     noticed    by     the   CESTAT     in    Araco
                Corporation v. CCE [2005] (180) ELT 91 (Tri-
                Bang).

                4.8.5          By   the    expedient   of   "deeming


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ITA 1034/2009                                                      Page 22 of 174
                fiction" or inclusive definition" Parliament and
                State Legislatures are competent to give a
                specific definition to a particular transaction.
                Such definition is confined to the specific
                statute     only.    Such      definition       cannot     be
                imported into a different statue which defines
                the same transaction differently. The necessary
                corollary is that "sales treatment: of computer
                software under sales tax law, does not, per se,
                influence income-tax treatment of software
                transactions, as income-tax law defines this
                transaction differently.

                4.8.6          OECD        recommendations            remain
                mere      recommendations              unless    they      are
                incorporated into domestic law and/or DTAAs.
                The distinction between "copyright right" and
                "program copy" recom mended by the OECD
                has been dissented from even by several
                member of the OECD. Indian laws and India's
                DTAA recognize only two types of transactions
                in respect of computer software sale and
                licence     (letting).    No   further        dissection    of
                licensing     (on        the   lines     of     the     OECD


=======================================================================

ITA 1034/2009                                                            Page 23 of 174
                commentary) is permitted under the Indian
                Copyright Act, Income-tax Act and Indian
                DTAAs. Therefore, notwithstanding attractive
                phraseology and nomenclature, any computer
                software licence fees, where the vendor retains
                ownership and grants user rights only to the
                licensee are, without an iota of doubt, taxable
                as royalties having an Indian source."

18.    On the basis of the findings/observations recorded by

       him, the CIT(A) held the income earned by the

       Assessee company from software licence is in the

       nature of royalty both under the domestic law and the

       DTAA and thus upheld the order of the AO holding the

       Income from software licence chargeable to tax in

       India as royalty under Section 9(1)(vi) of the Income

       Tax Act, 1961 read with Article 13 (Sic Article 12) of the

       DTAA.


19.    Aggrieved by the order of the AO as confirmed by the

       CIT(A), the Assessee Company filed an appeal before

       the Income Tax Appellate Tribunal (ITAT for Short).

=======================================================================

ITA 1034/2009                                             Page 24 of 174
       The ITAT noted that the amount received by the

       Assessee    company      had   been    treated   as     royalty

       income by the AO and the CIT(A) on the basis of

       Explanation 2 to Section 9(1)(vi) of the Act holding that

       there was transfer of some rights (including the

       granting of a licence) in respect of the copyright. The

       ITAT noted the stand of the Assessee company that

       there was no transfer of any right in respect of

       copyright by the Assessee and it was a case of mere

       transfer of a copyrighted article. The ITAT noted that if

       the payment received by the Assessee Company was

       for a copyright then it would classify as royalty both

       under the Income Tax Act, 1961 and under the DTAA.

       However, if the payment was for a copyrighted article

       then it would represent the purchase price of an article

       and could not be considered as royalty either under

       the Act or under the DTAA. The Tribunal noted the

       decision of a Special Bench of ITAT in the case of

       MOTOROLA INC., ERICSON R ADIO SYSTEM AB           AND   NOKIA


=======================================================================

ITA 1034/2009                                             Page 25 of 174
       NETWORKS OY     VS .   DEPUTY CIT (2005) 147 TAXMAN 39

       (DEL.). The Tribunal noted that the Special Bench of

       ITAT referring to the definition of "copyright", as given

       in Section 14 of the Copyright Act, 1957, had noted

       that the right mentioned in sub-clause (ii) of clause (b)

       of Section 14 was available only to a computer

       programme and if the licensees did not have any of

       such rights, as mentioned in clauses (a) and (b) of

       Section 14, it would mean that they did not have any

       right in the copyright and in such cases, the payments

       made to them could not be characterized as royalty

       under the Act for DTAA. The ITAT noted that the

       Special    Bench   of    the   Tribunal     in   the   case       of

       MOTOROLA INC. ( SUPRA), had held that since the

       licensees were not allowed to exploit the computer

       software   commercially,       they   had    acquired       under

       licence agreement, only the copy righted software

       which by itself was an article and not any copyright

       therein. The ITAT relying on the judgment in the case


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ITA 1034/2009                                                 Page 26 of 174
       of MOTOROLA INC. (SUPRA), noted that in the case of

       the Assessee company, the licensee to whom the

       Assessee company had sold/licensed to the software

       was allowed to make only one copy of the software

       and      associated    support     information   for     backup

       purposes with a condition that such copyright shall

       include    Infrasoft   copyright   and   all   copies     of    the

       software shall be exclusive properties of Infrasoft.

       Licensees was allowed to use the software only for its

       own business as specifically identified and was not

       permitted to loan/rent/sale/sub-licence or transfer the

       copy of software to any third party without the consent

       of Infrasoft. The licensee had been prohibited from

       copying,     de-compiling,   de-assembling,       or     reverse

       engineering the software without the written consent of

       Infrasoft. The ITAT further noted that the licence

       agreement between the Assessee Company and its

       customers stipulated that all copyrights and intellectual

       property rights in the software and copies made by the


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ITA 1034/2009                                                 Page 27 of 174
       licensee were owned by Infrasoft and only Infrasoft

       had the power to grant licence rights for use of the

       software. The ITAT further noted that the licence

       agreement stipulated that upon termination of the

       agreement for any reason, the licencee shall return the

       software including supporting information and licence

       authorization device to Infrasoft.


20.    The      ITAT   further   noted   that   the   CIT(A)      had

       distinguished the judgment in the case of MOTOROLA

       INC.(SUPRA) on the basis that the Assessee had

       purchased an integrated electronic switches system

       consisting of both hardware as well as software

       whereas in the present case, there was a licence of

       only the software without there being any sale of

       integrated hardware.      The ITAT further noted that the

       CIT(A) had not dealt with the aspect of the rights

       granted to the licensees as had been specifically

       noted in the case of MOTOROLA INC. (SUPRA).



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ITA 1034/2009                                             Page 28 of 174
21.    The ITAT further noted the decision of the ITAT

       Bangalore Bench in the case of SAMSUNG ELECTRONIC

       COMPANIES L TD.       VS .   INCOME TAX OFFICER (2005) 276

       ITR      PAGE   1 (BANGALORE ), wherein the Tribunal came

       to the conclusion that the incorporeal right to the

       software i.e. copyright had remained with the owner

       and the same was not transferred to the Assessee.

       The Tribunal in the case of SAMSUNG ELECTRONICS

       (SUPRA) had held that the right to use of a copyright is

       totally different from the right to use a programme

       embedded in a cassette or a CD which may be a

       software and the payment made for the same could

       not be said to be received as consideration for the use

       of or right to use of any copyright to bring it within the

       definition of royalty as given in the DTAA. It was held

       that what the Assessee had acquired was only a copy

       of the copyrighted articles whereas the copyright

       remained with the owner and the Assessee had

       acquired a computer programme for being used in its


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ITA 1034/2009                                             Page 29 of 174
       business and no right was granted to the Assessee to

       utilize the copyright of a computer programme and

       thus it was held that the payment for the same was not

       in the nature of royalty.


22.    The ITAT noted that the CIT(A) had distinguished the

       case of SAMSUNG ELECTRONICS (SUPRA) on the basis

       that the software licenced by the Assessee in the case

       of SAMSUNG ELECTRONICS (SUPRA ) was off the shelf

       software whereas the software in the case of the

       Assessee Company required to be customized to meet

       the needs of an Indian customer. The ITAT held that

       the customization of the concerned software or the

       professional   services     rendered    by   the   Assessee

       company for such customization had not resulted in

       any material change in the terms and conditions of the

       licence agreement or in the relationship between the

       Assessee as an owner of the software and a licensee

       to whom the right to use the said software was given

       by the Assessee company. The ITAT noted that the

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ITA 1034/2009                                             Page 30 of 174
       software provided by the Assessee Company was

       basically a standard software and the customization so

       done      to   the   limited   extent   as    per   the     specific

       requirements of the customers did not bring about any

       change in the nature of the software or the licence

       granted to the customers.


23.    The ITAT further held that the case of the Assessee

       Company was clearly covered by the decisions of the

       Tribunal in the case of M OTOROLA INC. (SUPRA)                    AND

       SAMSUNG ELECTRONICS (SUPRA).                 Following the said

       decisions, the ITAT held that the amount received by

       the      Assessee     under    the   licence    agreement          for

       allowing the use of the software was not royalty either

       under the Income Tax Act or under the DTAA. The

       ITAT set aside the order of the CIT(A) and restored

       the matter to the file of the AO with a direction to

       reframe the assessment in terms of the said decision.




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ITA 1034/2009                                                    Page 31 of 174
24.    Aggrieved    by     the     decision       of    the      ITAT   dated

       19.12.2008, the Revenue has filed the present appeal.


25.    Learned     counsel       for    the   appellant/revenue            has

       submitted that the Assessee Company had received

       amounts under the software licence agreement and

       the said amounts were in the nature of royalty and

       were chargeable to tax in terms of Section 9(1)(vi) of

       the Act. He further contended that the right to use of

       software    under     the       software        licence    agreement

       resulted in earning of royalty income and was thus

       chargeable to tax in the hands of the Assessee

       company as royalty income under Article 12 of the

       relevant DTAA.        He further contended that in the

       present case, there was no sale of the software but it

       was mere licence to use the software and as such, the

       receipt from such a sale was receipt towards royalty.

       Learned counsel for the appellant/Revenue further

       contended that royalty was defined in Explanation 2 to

       Section 9(i)(vi) to include consideration for transfer of

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ITA 1034/2009                                                      Page 32 of 174
       either      one   or   more   intellectual   property    rights

       mentioned therein and as such, there was no scope

       for an argument that computer software was not fully

       covered within the meaning of royalty. He further

       contended that computer software was one of the

       intellectual property referred to in the Explanation 2

       and transfer of rights therein by the licensor would

       give right to royalty income.


26.    Learned Counsel for the Revenue relied upon the

       decision of the Andhra Pradesh High Court in the case

       of       COMMISSIONER    OF   INCOME    T AX   VS   SAMSUNG

       ELECTRONICS CO. LTD (2012) 345 ITR 494 (KARN) to

       contend that right to make a copy of the software and

       storing the same in the hard disk of the designated

       computer and taking backup copy would amount to

       copyright work under section 14(1) of the Copyright

       Act and the payment made for the grant of the licence

       for the said purpose would constitute royalty.



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ITA 1034/2009                                              Page 33 of 174
27.    Contradicting the stand of the appellant/Revenue,

       learned    counsel     appearing      for     the    Assessee

       company/respondent        submitted         that    what     was

       transferred was neither the copyright in the software

       nor the use of the copyright in the software, but what

       was transferred was the right to use the copyrighted

       material which was clearly distinct from the rights in a

       copyright. Learned counsel contended that no doubt, if

       right to use the copyright had been transferred, the

       same would give rise to royalty. But where right that is

       transferred is not a right to use the copyright but is

       only limited to the right to use the copyrighted material,

       the same would not give rise to any royalty income

       and would be business income.


28.    We have examined the rival contentions of the parties

       and are of the view that there is no infirmity in the

       impugned order and what has been transferred is not

       copyright or the right to use copyright but a limited



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ITA 1034/2009                                                Page 34 of 174
       right to use the copyrighted material and does not give

       rise to any royalty income.


29.    In the present day global economy it is not unusual for

       an       individual   or   a   business   entity   to     operate

       commercially in more than one countries. When an

       individual or business entity which is resident in one

       country makes a taxable gain in another country the

       said individual or         entity   may be   obliged by the

       domestic laws to pay tax on the income locally as well

       as in the country in which the income was so earned.

       The result of such a situation is that an individual or

       entity may become liable to double taxation, one in the

       resident country and the other in the country in which

       the income so arises. In this situation both the

       countries may make the said individual or entity liable

       to tax with the result that the individual/entity may end

       up paying tax in both the countries. To avoid such an

       inequitable situation many nations enter into bilateral

       double taxation agreements with each other.

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ITA 1034/2009                                                  Page 35 of 174
30.    The bilateral double taxation agreements generally lay

       down two situations, in the first situation the individual

       may be required to pay tax in the country of residence

       and is exempted in the country in which the income

       arises. In the other situation the country where the

       income arises deducts tax at source and the taxpayer

       receives compensation in the form of a foreign tax

       credit in the country of residence which would entitle

       the taxpayer to a credit in the country of residence to

       the extent the income that has been taxed in the

       country where the income has so arisen. To be able to

       avail the benefit of foreign tax credit the Assessee has

       to declare himself (in the country where income has

       arisen) to be a non-resident.


31.    India has comprehensive double taxation avoidance

       agreements     with   various    countries.    The    double

       taxation avoidance agreement that India has entered

       into with various countries stipulate agreed rate of tax



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ITA 1034/2009                                             Page 36 of 174
       and jurisdiction on specified types of income arising in

       a country to tax resident of another country.


32.    To resolve the controversy, we would need to examine

       some of the relevant provisions of the Income Tax Act

       and      the    Indo    US    Double      Taxation     Avoidance

       Agreement.


33.    Section 90 of the Act, 1961 lays down as under:

                "90. (1) The Central Government may enter
                into an agreement with the Government of any
                country    outside India or   specified    territory
                outside India,--

                (a) for the granting of relief in respect of --

                      (i) income on which have been paid both
                      income-tax under this Act and income-
                      tax in that country or specified territory,
                      as the case may be, or

                      (ii) income-tax chargeable under this Act
                      and under the corresponding law in force
                      in that country or specified territory, as


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ITA 1034/2009                                                     Page 37 of 174
                       the case may be, to promote mutual
                       economic        relations,         trade     and
                       investment, or

                (b) for the avoidance of double taxation of
                income      under   this     Act    and    under     the
                corresponding law in force in that country or
                specified territory, as the case may be, or

                (c)   for   exchange    of    information     for    the
                prevention of evasion or avoidance of income-
                tax chargeable under this Act or under the
                corresponding law in force in that country or
                specified territory, as the case may be, or
                investigation of cases of such evasion or
                avoidance, or

                (d) for recovery of income-tax under this Act
                and under the corresponding law in force in
                that country or specified territory, as the case
                may be, and may, by notification in the Official
                Gazette, make such provisions as may be
                necessary for implementing the agreement.




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ITA 1034/2009                                                       Page 38 of 174
                (2) Where the Central Government has entered
                into an agreement with the Government of any
                country outside India or specified territory
                outside India, as the case may be, under sub-
                section (1) for granting relief of tax, or as the
                case may be, avoidance of double taxation,
                then, in relation to the Assessee to whom such
                agreement applies, the provisions of this Act
                shall apply to the extent they are more
                beneficial to that Assessee.

                (3) Any term used but not defined in this Act or
                in the agreement referred to in sub-section (1)
                shall, unless the context otherwise requires,
                and is not inconsistent with the provisions of
                this Act or the agreement, have the same
                meaning as assigned to it in the notification
                issued by the Central Government in the
                Official Gazette in this behalf.

                Explanation 1. --For the removal of doubts, it is
                hereby declared that the charge of tax in
                respect of a foreign company at a rate higher
                than the rate at which a domestic company is
                chargeable,    shall   not     be   regarded     as

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ITA 1034/2009                                                  Page 39 of 174
                less favourable charge or levy of tax in respect
                of such foreign company.

                Explanation   2. --For the    purposes    of    this
                section, "specified territory" means any area
                outside India which may be notified as such by
                the Central Government.]

34.    Section 90 of the Act gives relief to the taxpayer who

       have paid the tax to a country with which India has

       signed the double taxation avoidance agreement.

       Section      90   confers    the      power   on   the      Central

       government to enter into any agreement with the

       government of another country for granting relief to an

       Assessee who has paid income tax under this Act and

       also income tax in that other country and also in

       respect of income tax which is chargeable under this

       Act and under the corresponding law of that country.

       This has been done with a view to promote mutual

       economic relations, trade and investment and for

       avoidance of double taxation of income under this Act


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ITA 1034/2009                                                   Page 40 of 174
       as well as the act of the said contracting country.

       Section 90 (2) lays down that where the Central

       Government has entered into an agreement with the

       government of any other country for granting relief of

       tax or for avoidance of double taxation, then the

       provisions of this Act shall apply to the Assessee only

       to the extent that they are more beneficial to the said

       Assessee. In case the provisions of this Act are more

       onerous and burdensome then the provisions of this

       Act would not apply and the Assessee would be

       governed squarely by the provisions of the double

       taxation avoidance agreement.


35.    Section 91 of the Act lays down as under:

                "91(1) If any person who is resident in India in
                any previous year proves that, in respect of his
                income which accrued or arose during that
                previous year outside India (and which is not
                deemed to accrue or arise in India), he has paid
                in   any   country   with   which   there   is     no
                agreement under section 90 for the relief or

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ITA 1034/2009                                                    Page 41 of 174
                avoidance of double taxation, income-tax, by
                deduction or otherwise, under the law in force
                in that country, he shall be entitled to the
                deduction from the Indian income-tax payable
                by him of a sum calculated on such doubly
                taxed income at the Indian rate of tax or the
                rate of tax of the said country, whichever is the
                lower, or at the Indian rate of tax if both the
                rates are equal.

                (2) If any person who is resident in India in any
                previous year proves that in respect of his
                income which accrued or arose to him during
                that previous year in Pakistan he has paid in
                that country, by deduction or otherwise, tax
                payable to the Government under any law for
                the time being in force in that country relating
                to taxation of agricultural income, he shall be
                entitled   to   a   deduction   from   the   Indian
                income-tax payable by him--

                      (a) of the amount of the tax paid in
                      Pakistan under any law aforesaid on such
                      income which is liable to tax under this
                      Act also; or

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ITA 1034/2009                                                  Page 42 of 174
                      (b) of a sum calculated on that income at
                      the Indian rate of tax;

                whichever is less.

                (3) If any non-resident person is assessed on
                his share in the income of a registered firm
                assessed as resident in India in any previous
                year and such share includes any income
                accruing or arising outside India during that
                previous year (and which is not deemed to
                accrue or arise in India) in a country with which
                there is no agreement under section 90 for the
                relief or avoidance of double taxation and he
                proves   that   he   has   paid   income-tax     by
                deduction or otherwise under the law in force
                in that country in respect of the income so
                included he shall be entitled to a deduction
                from the Indian income-tax payable by him of a
                sum calculated on such doubly taxed income so
                included at the Indian rate of tax or the rate of
                tax of the said country, whichever is the lower,
                or at the Indian rate of tax if both the rates are
                equal.


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ITA 1034/2009                                                  Page 43 of 174
                Explanation.--In this section, --

                (i)   the expression "Indian income -tax" means
                income-tax 73[***] charged in accordance with
                the provisions of this Act;

                (ii) the expression "Indian rate of tax" means
                the rate determined by dividing the amount of
                Indian income-tax after deduction of any relief
                due under the provisions of this Act but before
                deduction     of    any       relief    due     under
                this 74[Chapter], by the total income;

                (iii) the expression "rate of tax of the said
                country"    means   income -tax        and   super-tax
                actually paid in the said country in accordance
                with the corresponding laws in force in the said
                country after deduction of all relief due, but
                before deduction of any relief due in the said
                country in respect of double taxation, divided
                by the whole amount of the income as
                assessed in the said country;

                (iv) the expression "income -tax" in relation to
                any country includes any excess profits tax or


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ITA 1034/2009                                                     Page 44 of 174
                business profits tax charged on the profits by
                the Government of any part of that country or
                a local authority in that country.

36.    Section 91 of the Act provides relief to the taxpayers

       who have paid taxes to a country with which India has

       not signed a double taxation avoidance agreement.

       This actually gives relief to Assessee in both situations,

       one where there is a double taxation avoidance

       agreement with a corresponding country under section

       90 and second in cases where there is no double

       taxation      avoidance     agreement     under   section    91.

       Under the provisions of section 91 a person who has

       paid tax in any country with which there is no

       agreement under section 90, would be entitled to

       deduction from the Indian income tax payable by him

       of a sum calculated on such doubly taxed income at a

       lower of the two rates of tax that is Indian rate of tax or

       the rate of tax of the said country whichever is lower




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ITA 1034/2009                                              Page 45 of 174
       and in case both the rates are equal then at the Indian

       rate of tax.


37.    In the case of DIT        V.    RIO TINTO TECHNICAL SERVICES

       (2012) 340 ITR 507 (DEL) the Delhi High Court has

       held as under:

                Section 90(2) mandates that where the Central
                Government      has     entered    into     a    Double
                Taxation Avoidance Agreement under sub-
                section (1) for granting relief of tax or, as the
                case may be, avoidance of double taxation,
                then in relation to the assessee to whom the
                agreement applies, the provisions of the Act
                apply to the extent they are more beneficial to
                the assessee. In other words, where an article
                in a Double Taxation Avoidance Agreement and
                a provision of the Act apply to the assessee,
                then   the   article    of   the   Double       Taxation
                Avoidance Agreement or the provision the Act
                will apply depending upon which one of the
                two is more beneficial/advantageous to the
                assessee. The first requirement, therefore, is to
                see whether the provisions of the Act apply to

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ITA 1034/2009                                                       Page 46 of 174
                a particular transaction undertaken/ income
                earned by an assessee, which is taxable in India
                under the Act. In case the transaction/income
                is not taxable under the Act, the income
                earned would not be taxed. In case the said
                transaction or income of an assessee is taxable
                under the Act, then the provisions of the
                Double     Taxation    Avoidance     Agreement,      if
                applicable, may be resorted to if they are more
                beneficial and advantageous to the assessee,
                i.e., if they negate or reduce the tax liability. In
                AZADI     BACHAO       ANDOLAN      (SUPRA)     after
                referring to the said section it has been held
                (pages 722 and 724) :

                        "The provisions of sections 4 and 5 of the
                        Act are expressly made 'subject to the
                        provisions of this Act', which would
                        include section 90 of the Act. As to what
                        would happen in the event of a conflict
                        between the provision of the Income-tax
                        Act and a notification issued          under
                        section 90, is no longer res integra . . .




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ITA 1034/2009                                                    Page 47 of 174
                  A survey of the aforesaid cases makes it
                  clear that the judicial consensus in India
                  has been that section 90 is specifically
                  intended to enable and empower the
                  Central     Government       to    issue       a
                  notification for implementation of the
                  terms of a Double Taxation Avoidance
                  Agreement. When that happens, the
                  provisions of such an agreement, with
                  respect to cases to which they apply,
                  would operate even if inconsistent with
                  the provisions of the Income-tax Act. We
                  approve of the reasoning in the decisions
                  which we have noticed. If it was not the
                  intention of the Legislature to make a
                  departure from the general principle of
                  chargeability to tax under section 4 and
                  the general principle of ascertainment of
                  total income under section 5 of the Act,
                  then there was no purpose in making
                  those sections 'subject to the provisions'
                  of the Act. The very object of grafting the
                  said two sections with the said clause is
                  to enable the Central Government to

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ITA 1034/2009                                                Page 48 of 174
                       issue a notification under section 90
                       towards implementation of the terms of
                       DTAs which would automatically override
                       the provisions of the Income-tax Act in
                       the     matter     of   ascertainment     of
                       chargeability      to   income-tax      and
                       ascertainment of total income, to the
                       extent of inconsistency with the terms of
                       DTAC."

38.    The Supreme Court of India in the case of AZADI

       BACHAO ANDOLAN (SUPRA) has laid down that in case of

       conflict       the    provisions   of   the   Double    Taxation

       Avoidance Agreement would prevail over the statutory

       provisions of the Act in case the same are more

       beneficial to the Assessee and while discussing the

       judgments of various High Courts has held as under:

                22.    The     Andhra     Pradesh    High     Court
                in CIT v. Visakhapatnam Port Trust [(1983) 144
                ITR 146 (AP)] held that provisions of Sections 4
                and 5 of the Income Tax Act are expressly
                made "subject to the provisions of the Act"


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ITA 1034/2009                                                  Page 49 of 174
                which means that they are subject to the
                provisions   of    Section    90.     By   necessary
                implication, they are subject to the terms of
                the Double Taxation Avoidance Agreement, if
                any, entered into by the Government of India.
                Therefore,   the   total     income    specified   in
                Sections 4 and 5 chargeable to income tax is
                also subject to the provisions of the agreement
                to the contrary, if any.

                23.   In CIT v. Davy Ashmore India Ltd. [(1991)
                190 ITR 626 (Cal)] while dealing with the
                correctness of Circular No. 333 dated 2-4-1982,
                it was held that the conclusion is inescapable
                that in case of inconsistency between the
                terms of the Agreement and the taxation
                statute, the Agreement alone would prevail.
                The Calcutta High Court expressly approved the
                correctness of CBDT Circular No. 333 dated 2-
                4-1982 on the question as to               what the
                assessing officers would have to do when they
                found that the provision of the double taxation
                was not in conformity with the Income Tax Act,



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ITA 1034/2009                                                   Page 50 of 174
                1961. The said circular provided as follows
                (quoted at ITR p. 632):

                      "The correct legal position is that w here
                      a specific provision is made in the Double
                      Taxation   Avoidance   Agreement,    that
                      provision will prevail over the general
                      provisions contained in the Income Tax
                      Act, 1961. In fact the Double Taxation
                      Avoidance Agreements which have been
                      entered into by the Central Government
                      under Section 90 of the Income Tax Act,
                      1961, also provide that the laws in force
                      in either country will continue to govern
                      the assessment and taxation of income in
                      the respective country except where
                      provisions to the contrary have been
                      made in the Agreement.

                Thus, where a Double Taxation Avoidance
                Agreement provided for a particular mode of
                computation of income, the same should be
                followed, irrespective of the provisions in the
                Income Tax Act. Where there is no specific
                provision in the Agreement, it is the basic law

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ITA 1034/2009                                              Page 51 of 174
                i.e. the Income Tax Act, that will govern the
                taxation of income.

                24.   The Calcutta High Court held that the
                circular reflected the correct legal position
                inasmuch as the convention or agreement is
                arrived at by the two c ontracting States "in
                deviation   from   the    general    principles     of
                taxation applicable to the contracting States".
                Otherwise, the Double Taxation Avoidance
                Agreement will have no meaning at all. [See
                also in this connection Leonhardt Andra Und
                Partner, GmbH v. CIT, (2001) 249 ITR 418 (Cal)]

                25.   In CIT v. R.M. Muthaiah [(1993) 202 ITR
                508 (Kant)] the Karnataka High Court was
                concerned     with       DTAT       between        the
                Government of India and the Government of
                Malaysia. The High Court held that under the
                terms of the Agreement, if there was a
                recognition of the power of taxation with the
                Malaysian Government, by implication it takes
                away the corresponding power of the Indian
                Government. The Agreement was thus held to
                operate as a bar on the power of the Indian

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ITA 1034/2009                                                     Page 52 of 174
                Government to tax and that the bar would
                operate on Sections 4 and 5 of the Income Tax
                Act, 1961, and take away the power of the
                Indian Government to levy tax on the income
                in respect of certain categories as referred to
                in certain articles of the Agreement. The High
                Court summed up the situation by observing
                (ITR at pp. 512-513):

                      "The effect of an `agreement' entered
                      into by virtue of Section 90 of the Act
                      would be: (i) if no tax liability is imposed
                      under this Act, the question of resorting
                      to the agreement would not arise. No
                      provision of the agreement can possibly
                      fasten a tax liability where the liability is
                      not imposed by this Act; (ii) if a tax
                      liability is imposed by this Act, the
                      agreement     may    be    resorted     to    for
                      negativing or reducing it; (iii) in case of
                      difference between the provisions of the
                      Act and of the agreement, the provisions
                      of   the   agreement      prevail     over    the
                      provisions   of   this    Act   and    can     be


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ITA 1034/2009                                                      Page 53 of 174
                      enforced by the Appellate Authorities
                      and the court.

                28.   A survey of the aforesaid cases makes it
                clear that the judicial consensus in India has
                been that section 90 is specifically intended to
                enable and empower the Central Government
                to issue a notification for implementation of
                the terms of a Double Taxation Avoidance
                Agreement. When that happens, the provisions
                of such an agreement, with respect to cases to
                which they apply, would operate even if
                inconsistent with the provisions of the Income-
                tax Act. We approve of the reasoning in the
                decisions which we have noticed. If it was not
                the intention of the Legislature to make a
                departure   from   the   general   principle     of
                chargeability to tax under section 4 and the
                general principle of ascertainment of total
                income under section 5 of the Act, then there
                was no purpose in making those sections
                'subject to the provisions' of the Act. The very
                object of grafting the said two sections with
                the said clause is to enable the Central


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ITA 1034/2009                                                  Page 54 of 174
                Government to issue a notification under
                section 90 towards implementation of the
                terms of DTAs which would automatically
                override the provisions of the Income-tax Act
                in the matter of ascertainment of chargeability
                to income-tax and ascertainment of total
                income, to the extent of inconsistency with the
                terms of DTAC.

39.    In the case of AZADI BACHAO ANDOLAN (SUPRA) the

       Supreme Court of India has thus specifically laid down

       that provisions of Sections 4 and 5 of the Income Tax

       Act are subject to the provisions of Section 90 thus

       they are subject to the terms of the Double Taxation

       Avoidance Agreement, if any, entered into by the

       Government of India. Therefore, the total income

       specified in Sections 4 and 5 chargeable to income tax

       is also subject to the provisions of the agreement to

       the contrary, if any. It has thus held that the conclusion

       is inescapable that in case of inconsistency between

       the terms of the Agreement and the taxation statute,


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ITA 1034/2009                                             Page 55 of 174
       the      Agreement    alone        would    prevail,    when      the

       agreement is more beneficial. Where a provision is

       made in the Double Taxation Avoidance Agreement,

       that provision will prevail over the general provisions

       contained in the Act.


40.    Thus, where a Double Taxation Avoidance Agreement

       provides     is   more   advantageous         to   an   assessee,

       irrespective of the provisions in the Act, the agreement

       prevails. Where there is no provision in the Agreement,

       it is the basic law i.e. the Income Tax Act, that will

       govern the taxation of income.


41.    The      Supreme     Court    of    India   has    approved       the

       reasoning of the K ARNATAKA HIGH C OURT IN CIT V. R.M.

       MUTHAIAH (SUPRA) that the effect of an ,,agreement

       entered into by virtue of Section 90 of the Act would be:

       (i) if no tax liability is imposed under this Act, the

       question of resorting to the agreement would not arise.

       No provision of the agreement can possibly fasten a


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ITA 1034/2009                                                   Page 56 of 174
       tax liability where the liability is not imposed by this Act;

       (ii) if a tax liability is imposed by this Act, the

       agreement may be resorted to for negativing or

       reducing it; (iii) subject to above, in case of difference

       between     the    provisions       of   the   Act       and      of    the

       agreement, the provisions of the agreement prevail

       over the provisions of this Act and can be enforced by

       the Appellate Authorities and the court.


42.    The Supreme Court of India has thus held that the

       judicial consensus in India has been that section 90 is

       specifically intended to enable and empower the

       Central   Government           to    issue     a    notification         for

       implementation of the terms of a Double Taxation

       Avoidance      Agreement.           When     that       happens,        the

       provisions of such an agreement, with respect to

       cases to which they apply, would operate even if

       inconsistent      with   the    provisions         of    the     Act,     to

       advantage of an assessee. A notification under section

       90 towards implementation of the terms of DTAs which

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ITA 1034/2009                                                         Page 57 of 174
       would automatically override the provisions of the Act

       in the matter of ascertainment of chargeability to

       income-tax and ascertainment of total income, rate of

       tax etc. to the extent of inconsistency with the terms of

       DTAA.


43.    The Supreme Court while dealing with the concept of

       liability to taxation in international transactions in AZADI

       BACHAO ANDOLAN (SUPRA) further laid down as under:

                What is "liable to taxation"?
                Fiscal residence

                62.   The concept of "fiscal residence" of a
                company      assumes     importance      in     the
                application and interpretation of the Double
                Taxation Avoidance Treaties.

                63.   In Cahiers       De       Droit         Fiscal
                International [ Jean-Maio Rivier: Cahiers De
                Droit Fiscal International, Vol. LXXIIa at pp. 47-
                76.] it is said that under the OECD and UNO
                Model Conventions, "fiscal residence" is a
                place where a person, amongst others a

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ITA 1034/2009                                                  Page 58 of 174
                corporation, is subjected to unlimited fiscal
                liability and subjected to taxation for the
                worldwide profit of the resident company. At
                paragraph 2.2 it is pointed out:

                      "The UNO Model Convention takes these
                      two different concepts into account. It
                      has not embodied the second sentence
                      of Article 4, paragraph (1) of the OECD
                      Model Convention, which provides that
                      the term `resident' does not include any
                      person who is liable to tax in that State in
                      respect only of income from sources in
                      that State. In fact, if one adhered to a
                      strict interpretation of this text, there
                      would be no resident in the meaning of
                      the Convention in those States that apply
                      the principle of territoriality."

                Again in paragraph 3.5 it is said:

                      "The existence of a company from a
                      company     law    standpoint       is   usually
                      determined under the law of the State of
                      incorporation or of the country where


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ITA 1034/2009                                                    Page 59 of 174
                      the real seat is located. On the other
                      hand, the tax status of a corporation is
                      determined under the law of each of the
                      countries where it carries on business, be
                      it as resident or non-resident."

                64.   In paragraph 4.1 it is observed that the
                principle of universality of taxation i.e. the
                principle of worldwide taxation, has been
                adopted by a majority of States. One has to
                consider the worldwide income of a company
                to determine its taxable profit. In this system it
                is crucial to define the fiscal residence of a
                company      very    accurately.    The   State     of
                residence is the one entitled to levy tax on the
                corporation's worldwide profit. The company is
                subject to unlimited fiscal liability in that State.
                In the case of a company, however, several
                factors enter the picture and render the
                decision    difficult.   First,   the   company      is
                necessarily incorporated and usually registered
                under the tax law of a State that grants it
                corporate      status.     A      corporation      has
                administrative      activities,     directors     and


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ITA 1034/2009                                                     Page 60 of 174
                managers who reside, meet and take decisions
                in one or several places. It has activities and
                carries on business. Finally, it has shareholders
                who control it. Hence, it is opined:

                      "When all these elements coexist in the
                      same country, no complications arise. As
                      soon   as     they    are    dissociated     and
                      `scattered'   in     different     States,   each
                      country      may     want    to    subject    the
                      company to taxation on the basis of an
                      element to which it gives preference;
                      incorporation procedure, management
                      functions,    running       of    the   business,
                      shareholders'         controlling         power.
                      Depending on the criterion adopted,
                      fiscal residence will abide in one or the
                      other country.

                      All the European countries concerned,
                      except France, levy tax on the worldwide
                      profit at the place of residence of the
                      company considered.




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ITA 1034/2009                                                      Page 61 of 174
                      South Korea, India and Japan in Asia,
                      Australia and New Zealand in Oceania
                      follow this principle."

                91.   In our view, the contention of the
                respondents     proceeds       on      the   fallacious
                premise that liability to taxation is the same as
                payment of tax. Liability to taxation is a legal
                situation; payment of tax is a fiscal fact. For the
                purpose of application of Article 4 of DTAC,
                what is relevant is the legal situation, namely,
                liability to taxation, and not the fiscal fact of
                actual payment of tax. If this were not so, DTAC
                would not have used the words "liable to
                taxation",    but   would       have     used    some
                appropriate words like "pays tax". On the
                language of DTAC, it is not possible to accept
                the   contention    of   the     respondents      that
                offshore     companies         incorporated        and
                registered under MOBA are not "liable to
                taxation" under the Mauritian Income Tax Act;
                nor is it possible to accept the contention that
                such companies would not be "resident" in




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ITA 1034/2009                                                     Page 62 of 174
                Mauritius within the meaning of Article 3 read
                with Article 4 of DTAC.

                93.   In A Manual on the OECD Model Tax
                Convention on Income and on Capital, at para
                4B.05, while commenting on Article 4 of the
                OECD Double Tax Convention, Philip Baker
                points out that the phrase "liable to tax" used
                in the first sentence of Article 4.1 of the Model
                Convention has raised a number of issues, and
                observes:

                      "It seems clear that a person does not
                      have to be actually paying tax to be
                      `liable to tax' -- otherwise a person who
                      had deductible losses or allowances,
                      which reduced his tax bill to zero would
                      find himself unable to enjoy the benefits
                      of the Convention. It also seems clear
                      that a person who would otherwise be
                      subject to comprehensive taxing but who
                      enjoys a specific exemption from tax is
                      nevertheless   liable   to   tax,   if    the
                      exemption were repealed, or the person
                      no longer qualified for the exemption,

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ITA 1034/2009                                                  Page 63 of 174
                      the    person     would     be    liable     to
                      comprehensive taxation."

                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."

                100. Interpreting the article of the Treaty
                Against Avoidance of Double Taxation, the
                Federal Court said (at p. 5):

                      "The non-resident can benefit from the
                      exemption regardless of whether or not

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ITA 1034/2009                                                    Page 64 of 174
                     he is taxable on that capital gain in his
                     own country. If Canada or the US were to
                     abolish capital gains completely, while
                     the other country did not, a resident of
                     the country which had abolished capital
                     gains would still be exempt from capital
                     gains in the other country."

                103. According to Klaus Vogel:

                     "Double Taxation Convention establishes
                     an independent mechanism to avoid
                     double taxation through restriction of tax
                     claims in areas where overlapping tax
                     claims   are   expected,    or   at   least
                     theoretically possible. In other words,
                     the contracting States mutually bind
                     themselves not to levy taxes or to tax
                     only to a limited extent in cases when the
                     treaty reserves taxation for the other
                     contracting States either entirely or in
                     part. Contracting States are said to
                     `waive' tax claims or more illustratively,
                     to divide `tax sources', the `taxable
                     objects', amongst themselves."

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ITA 1034/2009                                              Page 65 of 174
                Double Taxation Avoidance Treaties were in
                vogue even from the time of the League of
                Nations. The experts appointed in the early
                1920s by the League of Nations describe this
                method of classification of items and their
                assignments to the contracting States. While
                the English lawyers called it "classification and
                assignment rules", the German jurists called it
                "the distributive rule" (Verteilungsnorm). To
                the extent that an exemption is agreed to, its
                effect is in principle independent of both
                whether the other contracting State imposes a
                tax in the situation to which the exemption
                applies, and of whether that State actually
                levies the tax. Commenting particularly on the
                German Double Taxation Convention with the
                United States, Vogel comm ents: "Thus, it is
                said that the treaty prevents not only `current',
                but also merely `potential' double taxation."
                Further, according to Vogel,

                      "only in exceptional cases, and only when
                      expressly agreed to by the parties, is
                      exemption    in   one    contracting   State


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ITA 1034/2009                                                Page 66 of 174
                          dependent upon whether the income or
                          capital is taxable in the other contracting
                          State, or upon whether it is actually
                          taxed there". * See in this connection
                          Klaus Vogel: Double Taxation Convention,
                          pp. 26-29 (3rd Edn.).]

44.    The Supreme Court of India in the AZADI BACHAO

       ANDOLAN (SUPRA) has thus laid down that the concept

       of       "fiscal     residence"    of    a   company       assumes

       importance in the application and interpretation of the

       DTAAs.             The       Supreme    Court   referred     to     the

       Commentary of Jean-Maio Rivier "Cahiers De Droit

       Fiscal International" that under the OECD and UNO

       Model Conventions, "fiscal residence" is a place where

       a person, amongst others a corporation, is subjected

       to unlimited fiscal liability and subjected to taxation for

       the worldwide profit of the resident company. The

       existence          of    a    company    from   a   company        law

       standpoint is usually determined under the law of the

       State of incorporation or of the country where the real

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ITA 1034/2009                                                     Page 67 of 174
       seat is located. On the other hand, the tax status of a

       corporation is determined under the law of each of the

       countries where it carries on business, be it as

       resident or non-resident.


45.    The      Supreme   Court    held   that   the   principle     of

       universality of taxation i.e. the principle of worldwide

       taxation, has been adopted by a majority of States.

       One has to consider the worldwide income of a

       company to determine its taxable profit. In this system

       it is crucial to define the fiscal residence of a company

       very accurately. The State of residence is the one

       entitled to levy tax on the corporation's worldwide

       profit. The company is subject to unlimited fiscal

       liability in that State. In the case of a company,

       however, several factors enter the picture and render

       the decision difficult. First, the company is necessarily

       incorporated and usually registered under the tax law

       of a State that grants it corporate status. A corporation

       has administrative activities, directors and managers

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ITA 1034/2009                                             Page 68 of 174
       who reside, meet and take decisions in one or several

       places. It has activities and carries on business.

       Finally, it has shareholders who control it. When all

       these elements coexist in the same country, no

       complications arise. As soon as they are dissociated

       and ,,scattered in different States, each country may

       want to subject the company to taxation on the basis

       of       an   element    to   which   it   gives   preference;

       incorporation      procedure,     management        functions,

       running of the          business, shareholders'     controlling

       power. Depending on the criterion adopted, fiscal

       residence will abide in one or the other country.


46.    The Supreme Court held that liability to taxation is a

       legal situation; payment of tax is a fiscal fact. For the

       purpose of application of Article 4 of DTAA, what is

       relevant is the legal situation, namely, liability to

       taxation, and not the fiscal fact of actual payment of

       tax. The Supreme Court quoted with approval the

       commentary of Philip Baker on Article 4 of the OECD

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ITA 1034/2009                                               Page 69 of 174
       Double Tax Convention that a person does not have to

       be actually paying tax to be ,,liable to tax


47.    The Supreme Court further referred to the Judgment

       of the       Federal      Court in          John     N.   Gladden v. Her

       Majesty          the   Queen (supra)          that    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. The non-resident can

       benefit from the exemption regardless of whether or

       not he is taxable on that capital gain in his own

       country. If Canada or the US were to abolish capital

       gains completely, while the other country did not, a

       resident of the country which had abolished capital

       gains would still be exempt from capital gains in the

       other country.

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ITA 1034/2009                                                           Page 70 of 174
48.    The Supreme Court further referred to the commentary

       of Klaus Vogel that Double Taxation Convention

       establishes       an     independent       mechanism         to   avoid

       double taxation through restriction of tax claims in

       areas where overlapping tax claims are expected, or

       at least theoretically possible. In other words, the

       contracting States mutually bind themselves not to

       levy taxes or to tax only to a limited extent in cases

       when     the    treaty    reserves        taxation   for   the     other

       contracting States either entirely or in part. Contracting

       States    are     said    to   ,,waive      tax   claims     or    more

       illustratively,   to     divide   ,,tax   sources,     the     ,,taxable

       objects, amongst themselves.


49.    In the present case the respondent Assessee is the

       resident of USA with which India has signed a double

       taxation avoidance agreement. In terms of the Law as

       laid down by the Supreme Court of India in AZADI

       BACHAO ANDOLAN (SUPRA) the Assessee has the right to

       be governed by the provisions of the Income Tax Act

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ITA 1034/2009                                                       Page 71 of 174
       or   the   DTAA   whichever     is   more   beneficial.    The

       provisions of such an agreement, with respect to

       cases to which they apply, would operate even if

       inconsistent with the provisions of the Act and in case

       of inconsistency between the terms of the Agreement

       and the taxation statute, the Agreement alone would

       prevail. In the present case there is an Agreement for

       avoidance of double taxation between India and USA

       and the Assessee is covered by the same. The

       chargeability to tax of the income of the Assessee

       would have to be thus governed by the provisions of

       the DTAA i.e. India - US Double Taxation Avoidance

       Agreement. In case the income of the Assessee is

       chargeable under the DTAA then the provisions of the

       Agreement would prevail over the provisions of the Act,

       even if they are inconsistent with the DTAA.


50.    To further resolve the controversy we need to examine

       the provisions of the Indo US DTAA. We notice that

       the Authorities below and the Tribunal have referred to

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ITA 1034/2009                                             Page 72 of 174
       Article 13 of the Indo ­ UK DTAA whereas in the

       Memo of appeal the Revenue has relied upon Article

       12 of the Indo ­ US DTAA and both the counsels

       relied upon and referred to the Indo ­ US DTAA at the

       time of hearing of the present Appeal. The Provisions

       of Articles 7 and 13 of the Indo ­ UK DTAA and

       Articles 7 and 12 of the Indo ­ US DTAA for the

       purposes of the present case are pari-materia so we

       are referring to the same. Article 7 of the Indo ­ US

       DTAA stipulates as under:

                "1.   The profits of an enterprise of a Contracting
                State shall be taxable only in that State unless the
                enterprise    carries    on    business   in   the    other
                Contracting      State        through     a    permanent
                establishment situated therein. If the enterprise
                "carries on business " as aforesaid, the profits of the
                enterprise may be taxed in the other State but only
                so much of them as is attributable to (a) that
                permanent establishment; (b) sales in the other State
                of goods or merchandise of the same or similar kind
                as those sold through that permanent establishment;


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ITA 1034/2009                                                   Page 73 of 174
                or (c) other business activities carried on in the other
                State of the same or similar kind as those effected
                through that permanent establishment.

                2.    Subject to the provisions of paragraph 3, where
                an enterprise of a Contracting State carries on
                business in the other Contracting State through a
                permanent establishment situated therein, there
                shall "in each Contracting State " be attributed to
                that permanent establishment the profits which it
                might be expected to make if it were a distinct and
                independent enterprise engaged in the same or
                similar    activities    under        the          same      or   similar
                conditions and dealing "wholly" at arm's length with
                the   enterprise        of    which      it        is   a    permanent
                establishment and other enterprises controlling,
                controlled by or subject to the same common
                control as that enterprise. In any case where the
                correct    amount        of    profits        attributable          to    a
                permanent        establishment                is        incapable        of
                determination       or        the     determination               thereof
                presents     exceptional            difficulties,           the   profits
                attributable to the permanent establishment may be
                estimated on a reasonable basis. The estimate


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ITA 1034/2009                                                                 Page 74 of 174
                adopted shall, however, be such that the result shall
                be in accordance with the principles contained in
                this article.

                3.    In the determination of the profits of a
                permanent establishment, there shall be allowed as
                deductions expenses which are incurred for the
                purposes        of   the   business   of   the   permanent
                establishment, including a reasonable allocation of
                executive and general administrative expenses,
                research and development expenses, interest, and
                other expenses incurred for the purposes of the
                enterprise as a whole (or the part thereof which
                includes the permanent establishment), whether
                incurred in the State in which the permanent
                establishment         is   situated   or   elsewhere,       in
                accordance with the provisions of and subject to the
                limitations of the taxation laws of that State.
                However, no such deduction shall be allowed in
                respect of amounts, if any, paid (otherwise than
                towards reimbursement of actual expenses) by the
                permanent establishment to the head office of the
                enterprise or any of its other offices, by way of
                royalties, fees or other similar payments in return


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ITA 1034/2009                                                    Page 75 of 174
                for the use of patents, know-how or other rights, or
                by way of commission or other charges for specific
                services performed or for management, or, except
                in the case of banking enterprises, by way of interest
                on moneys lent to the permanent establishment.
                Likewise,   no   account    shall     be    taken,   in   the
                determination    of   the   profits    of    a   permanent
                establishment, for amounts charged (otherwise than
                toward reimbursement of actual expenses), by the
                permanent establishment to the head office of the
                enterprise or any of its other offices, by way of
                royalties, fees or other similar payments in return
                for the use of patents, know-how or other rights, or
                by way of commission or other charges for specific
                services performed or for management, or, except
                in the case of a banking enterprise, by way of
                interest on moneys lent to the head office of the
                enterprise or any of its other offices.

                4.     No profits shall be attributed to a permanent
                establishment by reason of the mere purchase by
                that    permanent     establishment         of   goods     or
                merchandise for the enterprise.



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ITA 1034/2009                                                    Page 76 of 174
                5.   For the purposes of this Convention, the profits
                to be attributed to the permanent establishment as
                provided in paragraph 1(a) of this article shall
                include only the profits derived from the assets and
                activities of the permanent establishment and shall
                be determined by the same method year by year
                unless there is good and sufficient reason to the
                contrary.

                6.   Where profits include items of income which
                are dealt with separately in other articles of the
                convention, then the provisions of those articles
                shall not be affected by the provisions of this article.

                7.   For the purposes of the Convention, the term "
                business profits " means income derived from any
                trade   or   business   including   income   from     the
                furnishing of services other than included services as
                defined in article 12 (royalties and fees for included
                services) and including income from the rental of
                tangible personal property other than property
                described in paragraph 3(b) of article 12 (royalties
                and fees for included services).

                                        (Emphasis Supplied)

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ITA 1034/2009                                                Page 77 of 174
51.    What Article 7 of the Double Taxation Avoidance

       Agreement     stipulates    is   that   the    profits    of    an

       enterprise would be exigible to tax only in a country

       where the enterprise is a resident. The exception to

       this has been carved out in Article 7, which stipulates

       that an enterprise can also be liable to tax in another

       country   where    the     enterprise   has     a   permanent

       establishment.    However, only so much of profits of

       such enterprise shall be taxed in the country where

       there is a permanent establishment other than the

       country of    residence     to the extent       the   same       is

       attributable to that permanent establishment or in

       respect of sales of goods or merchandise of same or

       similar   kind    as     sold    through      the   permanent

       establishment or other business activities effected

       through that permanent establishment.


52.    Clause 2 of Article 7 stipulates that attributability in

       each contracting State of profits would be only to the

       extent, such profits would arise in case the enterprise

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ITA 1034/2009                                                Page 78 of 174
       was a distinct and independent enterprise engaged in

       same or similar activity. The purport of the said clause

       is that where the enterprise carries on business

       through a permanent establishment, the profits would

       be calculat ed on the basis of an arms length principle

       which really implies that if two independent entities

       were carrying on business with each other. The profit

       that the    enterprise     would earn       through     the    said

       permanent establishment would be the profit that an

       independent enterprise would have earned if it was

       dealing with the enterprise in question. However, in

       case the profits were not so determinable than the

       reasonable     profits   on    estimation    basis    would       be

       carried out.


53.    Clause     3 of Article 7 lays down the deductible

       expenses which an enterprise would be entitled to

       while    computing       the   profits   attributable     to     the

       permanent         establishment.          The         permanent

       establishment is permitted to deduct expenses that are

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ITA 1034/2009                                                  Page 79 of 174
       incurred for the purposes of conduct of business of the

       permanent establishment. The broad expenses that

       are permitted to be deducted relate to execution, in

       general     administrative     expenses,        research     and

       development expenses, interest and other expenses

       incurred for the purposes of an enterprise as a whole

       irrespective of the fact whether the same are incurred

       in the country of residents of an enterprise or in a

       country where the permanent establishment is situated.

       The      clause   further   stipulates   that   no   deduction

       towards expenses would be allowed in respect of

       royalties, fees or other similar payments in return for

       the use of patents, knowhow or other rights or

       commission or other charges for management etc. are

       permitted. This is subject to limitations of the taxation

       laws of the State.


54.    Article 5 of the Indo US DTAA defines Permanent

       Establishment in Article 5 as under:



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ITA 1034/2009                                               Page 80 of 174
                "Permanent       establishment         -     1.    For    the
                purposes    of      this    Convention,           the    term
                "permanent establishment" means a fixed
                place of business through which the business
                of an enterprise is wholly or partly carried on.

                2.    The term "permanent establishment"
                includes especially:
                (a)   a place of management ;
                (b)    a branch ;
                (c)   an office ;
                (d)   a factory ;
                (e)   a workshop ;
                (f)   a mine, an oil or gas well, a quarry, or
                      any other place of extraction of natural
                      resources ;
                (g)   a warehouse, in relation to a person
                      providing storage facilities for others ;
                (h)   a farm, plantation or other place where
                      agriculture,         forestry,       plantation      or
                      related activities are carried on ;
                (i)   a store or premises used as a sales outlet ;
                (j)   an installation or structure used for the
                      exploration or exploitation of natural


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ITA 1034/2009                                                            Page 81 of 174
                      resources, but only if so used for a period
                      of more than 120 days in any twelve-
                      month period ;
                (k)   a      building        site    or        construction,
                      installation      or     assembly         project     or
                      supervisory       activities        in     connection
                      therewith, where such site, project or
                      activities (together with other such sites,
                      projects or activities, if any) continue for
                      a period of more than 120 days in any
                      twelve-month period ;
                (l)   the furnishing of services, other than
                      included services as defined in Article 12
                      (Royalties and Fees for Included Services),
                      within    a    Contracting          State     by      an
                      enterprise through employees or other
                      personnel, but only if:
                      (i)    activities of that nature continue
                             within that State for a period or
                             periods aggregating more than 90
                             days    within         any    twelve-month
                             period ; or
                      (ii)   the services are performed within
                             that State for a related enterprise

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ITA 1034/2009                                                             Page 82 of 174
                            [within the meaning of paragraph 1
                            of     Article       9     (Associated
                            Enterprises)].

                3.    Notwithstanding           the      preceding
                provisions of this Article, the term "permanent
                establishment" shall be deemed not to include
                any one or more of the following:

                (a)   the use of facilities solely for the purpose
                      of storage, display, or occasional delivery
                      of goods or merchandise belonging to
                      the enterprise ;

                (b)   the maintenance of a stock of goods or
                      merchandise belonging to the enterprise
                      solely for the purpose of storage, display,
                      or occasional delivery ;

                (c)   the maintenance of a stock of goods or
                      merchandise belonging to the enterprise
                      solely for the purpose of processing by
                      another enterprise ;

                (d)   the maintenance of a fixed place of
                      business   solely   for    the   purpose     of

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ITA 1034/2009                                                    Page 83 of 174
                        purchasing goods or merchandise, or of
                        collecting information, for the enterprise ;

                (e)     the maintenance of a fixed place of
                        business    solely      for       the       purpose     of
                        advertising, for the supply of information,
                        for   scientific   research         or       for   other
                        activities which have a preparatory or
                        auxiliary character, for the enterprise.

                4.      Notwithstanding          the        provisions          of
                paragraphs 1 and 2, where a person --other
                than an agent of an independent status to
                whom paragraph 5 applies - is acting in a
                Contracting State on behalf of an enterprise of
                the other Contracting State, that enterprise
                shall   be    deemed       to    have           a    permanent
                establishment in the first-mentioned State, if :

                (a)     he has and habitually exercises in the
                        first-mentioned State an authority to
                        conclude on behalf of the enterprise,
                        unless his activities are limited to those
                        mentioned in paragraph 3 which, if
                        exercised    through          a    fixed      place     of

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ITA 1034/2009                                                                 Page 84 of 174
                        business, would not make that fixed
                        place     of   business      a   permanent
                        establishment under the provisions of
                        that paragraph ;

                (b)     he has no such authority but habitually
                        maintains in the first-mentioned State a
                        stock of goods or merchandise from
                        which he regularly delivers goods or
                        merchandise on behalf of the enterprise,
                        and some additional activities conducted
                        in the State on behalf of the enterprise
                        have contributed to the sale of the goods
                        or merchandise ; or

                (c)     he habitually secures orders in the first-
                        mentioned State, wholly or almost wholly
                        for the enterprise.

                5.      An enterprise of a Contracting State shall
                not     be   deemed     to    have   a   permanent
                establishment in the other Contracting State
                merely because it carries on business in that
                other     State    through    a   broker,   general
                commission agent, or any other agent of an

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ITA 1034/2009                                                  Page 85 of 174
                independent       status,   provided    that   such
                persons are acting in the ordinary course of
                their business.

                However, when the activities of such an agent
                are devoted wholly or almost wholly on behalf
                of   that   enterprise      and   the   transactions
                between the agent and the enterprise are not
                made under arm's length conditions, he shall
                not be considered an agent of independent
                status within the meaning of this paragraph.

                6.    The fact that a company which is a
                resident of a Contracting State controls or is
                controlled by a company which is a resident of
                the other Contracting State, or which carries on
                business in that other State (whether through a
                permanent establishment or otherwise), shall
                not of itself constitute either company a
                permanent establishment of the other."

55.    Article 5 of the DTAA defines and lays down the

       number of conditions both positive and negative when




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ITA 1034/2009                                                  Page 86 of 174
       an       establishment     would     have     a      permanent

       establishment in the other contracting State.


56.    In the present case, it is an admitted position that the

       Respondent Assessee has a branch office in India

       which is a permanent establishment as defined in

       Article 5 of the DTAA. Since the Assessee has a

       permanent establishment in India in terms of the law

       as laid down by the Supreme Court of India in AZADI

       BACHAO ANDOLAN (SUPRA), the Assessee be liable to

       tax in India and as held hereinabove the chargeability

       to tax of the income of the Assessee would have to be

       governed by the provisions of the Indo US DTAA and

       the provisions of the Agreement would prevail over the

       provisions of the Act even if they are inconsistent with

       the same.


57.    Article 12 of the DTAA with USA stipulates as under:


                Royalties and fees for technical services



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ITA 1034/2009                                                Page 87 of 174
                1. Royalties or fees for technical services
                arising in a Contracting State and paid to a
                resident of the other Contracting State may be
                taxed in that other State.

                2. However, such royalties or fees for technical
                services may also be taxed in the Contracting
                State in which they arise, and according to the
                laws of that State, but if the beneficial owner
                of the royalties or fees for technical services is
                a resident of the other Contracting State the
                tax so charged shall not exceed 10 per cent. of
                the gross amount of the royalties or fees for
                technical services.

                3. The term "royalties " as used in this article
                means:

                      (a)   payments of any kind received as
                            consideration for the use of, or the
                            right to use, any copyright of a
                            literary, artistic, or scientific work,
                            including cinematograph films or
                            work on film, tape or other means
                            of   reproduction      for   use      in

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ITA 1034/2009                                                  Page 88 of 174
                           connection with radio or television
                           broadcasting,         any         patent,
                           trademark, design or model, plan,
                           secret formula or process, or for
                           information concerning industrial,
                           commercial or scientific experience,
                           including gains derived from the
                           alienation of any such right or
                           property which are contingent on
                           the productivity, use or disposition
                           thereof; and

                     (b)   payments of any kind received as
                           consideration for the use of, or the
                           right   to     use,   any      industrial,
                           commercial or scientific equipment,
                           other than payments derived by an
                           enterprise described in paragraph 1
                           of   article   8   (Shipping    and    Air
                           Transport) from activities described
                           in paragraph 2(c) or 3 or article 8.
                                              (Emphasis supplied)

                4.   For purposes of this article, "fees for
                included services " means payments of any

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ITA 1034/2009                                                    Page 89 of 174
                kind to any person in consideration for the
                rendering of any technical or consultancy
                services (including through the provision of
                services of technical or other personnel) if such
                services:

                      (a)    are ancillary and subsidiary to the
                             application or enjoyment of the
                             right, property or information for
                             which   a   payment     described    in
                             paragraph 3 is received; or

                      (b)    make        available         technical
                             knowledge, experience, skill, know-
                             how, or processes, or consist of the
                             development and transfer of a
                             technical plan or technical design.

                5.    --------

                6.    The provisions of paragraphs 1 and 2
                shall not apply if the beneficial owner of the
                royalties or fees for included services, being a
                resident of a Contracting State, carries on
                business in the other Contracting State, in


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ITA 1034/2009                                                  Page 90 of 174
                which the royalties or fees for included services
                arise, through a permanent establishment
                situated therein, or performs in that other
                State independent personal services from a
                fixed base situated therein, and the royalties or
                fees for included services are attributable to
                such permanent establishment or fixed base. In
                such case the provisions of article 7 (business
                profits) or article 15 (Independent Personal
                Services), as the case may be, shall apply.

                7.    ........

58.    Clause 1 of Article 12 lays down that royalty or fees for

       included services arising in a contracting State and

       paid to a residents of the other contracting State may

       be taxed in that other state.


59.    Clause 2 of Article 12 lays down that royalty and fees

       for      included     services   may   also   be   taxed     in    a

       contracting State in which they arise. However, if the

       beneficial owner of the royalties or fees for included

       services paid to the residents of the other contracting

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ITA 1034/2009                                                 Page 91 of 174
       State then the tax has been limited in percentage

       depending upon the number of years the convention

       has effect.


60.    Clause 3 of Article 12 lays down that the term royalty

       means payment of any kind received as consideration

       for the use of, or the right to use, any copyright of a

       literary, artistic, or scientific work.............., including

       gains derived from the alienation of any such right or

       property which are contingent on the productivity, use

       of deposition thereof. The term royalty has been

       defined by clause 3 of Article 12 as payment received

       for the use of, or the right to use any copyright.


61.    The amount received by the Assessee company had

       been treated as royalty income by the AO and the

       CIT(A) on the basis of Explanation 2 to Section 9(1)(vi)

       of the Act holding that there was transfer of some

       rights (including the granting of a licence) in respect of

       the copyright.


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ITA 1034/2009                                              Page 92 of 174
62.    In terms of the law as laid down by the Supreme Court

       of India in AZADI BACHAO ANDOLAN (SUPRA) and since

       the Assessee is governed by the Indo US DTAA, the

       income of the Assessee would be chargeable to tax in

       terms of the provision of the Indo US DTAA, if the

       same is more advantageous or beneficial. The AO and

       the CIT (A) have applied by the definition of the word

       'Royalty' as defined in Explanation 2 to Section 9(1)(vi)

       of the Act which is clearly contrary to the law as laid

       down by the Supreme Court of India in AZADI BACHAO

       ANDOLAN (SUPRA). Since the Assessee is governed by

       the      provisions   of   the   DTAA,   the   more    onerous

       provisions of the Act could not have been applied. If

       the provision of the Act were more beneficial that the

       provisions of the DTAA then only reliance on the same

       could have been placed by the AO.


63.    What is thus required to be examined is whether

       income of the Assessee is royalty income as covered

       by Article 12 of the DTAA if not then the same would

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ITA 1034/2009                                                Page 93 of 174
       be taxable as business income as covered by the

       provisions of Article 7 of the DTAA.


64.    To be taxable as royalty income covered by Article 12

       of the DTAA the income of the Assessee should have

       been generated by the "use of or the right to use of"

       any copyright.


65.    The issue whether consideration for software was

       royalty came up for consideration before the Special

       Bench       of   the   Tribunal   in   Delhi    in   the    case      of

       MOTOROLA INC           VS   DEPUTY CIT    AND    DEPUTY CIT          VS

       NOKIA (2005) 147 TAXMAN 39 (DELHI). The Tribunal has

       held as under:


                155. It appears to us from a close examination
                of the manner in which the case has proceeded
                before the Income-tax authorities and the
                arguments addressed before us that the crux of
                the issue is whether the payment is for a
                copyright or for a copyrighted article. If it is for
                copyright, it should be classified as royalty both

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ITA 1034/2009                                                     Page 94 of 174
                under the Income-tax Act and under the DTAA
                and it would be taxable in the hands of the
                Assessee on that basis. If the payment is really
                for    a    copyrighted   article,   then   it   only
                represents the purchase price of the article and,
                therefore, cannot be considered as royalty
                either under the Act or under the DTAA. This
                issue really is the key to the entire controversy
                and we may now proceed to address this issue.

                156. We must look into the meaning of the
                word "copyright" as given in the Copyright Act,
                1957. Section 14 of this Act defines "Copyright"
                as "the exclusive right subject to the provisions
                of this Act, to do or authorize the doing of any
                of the following acts in respect of a work or any
                substantial part thereof, namely:

                ---------

                It is clear from the above definition that a
                computer programme mentioned in Clause (b)
                of the section has all the rights mentioned in
                Clause (a) and in addition also the right to sell
                or give on commercial rental or offer for sale or

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ITA 1034/2009                                                    Page 95 of 174
                for   commercial    rental   any   copy   of    the
                computer programme. This additional right was
                substituted w.e.f. 15.1.2000. The difference
                between the earlier provision and the present
                one is not of any relevance. What is to be
                noted is that the right mentioned in Sub-clause
                (ii) of Clause (b) of Section 14 is available only
                to the owner of the computer programme. It
                follows that if any of the cellular operators
                does not have any of the rights mentioned in
                Clauses (a) and (b) of Section 14, it would mean
                that it does not have any right in a copyright. In
                that case, the payment made by the cellular
                operator cannot be characterized as royalty
                either under the Income-tax Act or under the
                DTAA. The question, therefore, to be answered
                is whether any of the operators can exercise
                any of the rights mentioned in the above
                provisions with reference to the software
                supplied by the Assessee.

                157. We may first look at the supply contract
                itself to find out what JTM, one of the cellular
                operators, can rightfully do with reference to


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ITA 1034/2009                                                  Page 96 of 174
                the software. We may remind ourselves that
                JTM is taken as a representative of all the
                cellular operators and that it was common
                ground before us that all the contracts with the
                cellular operators are substantially the same.
                Clause 20.1 of the Agreement, under the title
                "License", says that JTM is granted a non-
                exclusive restricted license to use the software
                and documentation but only for its own
                operation and maintenance of the system and
                not otherwise. This clause appears to militate
                against the position, if it were a copyright, that
                the holder of the copyright can do anything
                with respect to the same in the public domain.
                What JTM is permitted to do is only to use the
                software for the purpose of its own operation
                and maintenance of the system. There is a
                clear bar on the software being used by JTM in
                the public domain or for the purpose of
                commercial exploitation.

                158.   Secondly,   under    the    definition     of
                "copyright" in Section 14 of the Copyright Act,
                the emphasis is that it is an exclusive right


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ITA 1034/2009                                                   Page 97 of 174
                granted to the holder thereof. This condition is
                not satisfied in the case of JTM because the
                license granted to it by the Assessee is
                expressly stated in Clause 20.1 as a "non
                exclusive restricted license". This means that
                the supplier of the software, namely, the
                Assessee, can supply similar software to any
                number of cellular operators to which JTM can
                have no objection and further all the cellular
                operators can use the software only for the
                purpose    of     their   own        operation   and
                maintenance of the system and not for any
                other purpose. The user of the software by the
                cellular operators in the public domain is
                totally prohibited, which is evident from the
                use of the words in Article 20.1 of the
                agreement, "restricted" and "not otherwise".
                Thus JTM has a very limited right so far as the
                use of software is concerned. It needs no
                repetition to clarify that JTM has not been
                given any of the seven rights mentioned in
                Clause (a) of Section 14 or the additional right
                mentioned in Sub-clause (ii) of Clause (b) of the
                section   which     relates     to     a   computer

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ITA 1034/2009                                                    Page 98 of 174
                programme and, therefore, what JTM or any
                other cellular operator has acquired under the
                agreement is not a copyright but is only a
                copyrighted article.

                159. Clause 20.4 of the supply contract with
                JTM is as under:

                20.4 In pursuance of the foregoing JT MOBILES
                shall:

                (a) not provide or make the Software or
                Documentation or any portions or aspects
                thereof (including any methods or concepts
                utilized or expressed therein) available to any
                person except to its employees on a "need to
                know" basis;

                (b) not make any copies of Software or
                Documentation or parts thereof, except for
                archival backup purposes;

                (c) when making permitted copies as aforesaid
                transfer to the copy/copies any copyright or
                other    marking       on   the   Software     or
                Documentation.

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ITA 1034/2009                                                Page 99 of 174
                (d) Not use the Software or Documentation for
                any other purpose than permitted in this
                Article 20, Licence or sell or in any manner
                alienate or part with its possession.

                (e) Not use or transfer the Software and/or the
                Documentation     outside   India    without     the
                written consent of the Contractor and after
                having received necessary export or re-export
                permits from relevant authorities.

                This clause places stringent restrictions on the
                cellular operator so far as the use of software
                is concerned. It first says that the cellular
                operator cannot make the software or portions
                thereof available to any person except to its
                employees and even with regard to employees
                it has to be only on a "need to know basis"
                which means that even the employees are not
                to be told in all its aspects. What the Assessee
                can do is only to tell the particular employee
                what he has to know about the software for
                operational purposes. The cellular operator has
                been denied the right to make copies of the
                software or parts thereof except for archival

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ITA 1034/2009                                                  Page 100 of 174
                backup purposes. This means that the cellular
                operator cannot make copies of the software
                for commercial purposes. This condition is
                plainly contrary to Section 14(a)(i) of the
                Copyright Act which permits the copyright
                holder to reproduce the work in any material
                form including the storing of it in any medium
                by electronic means. We may also notice
                Section 52(1)(aa) of the Copyright Act which
                lists   out   certain   acts   which   cannot   be
                considered as infringement of copyright. The
                particular clause permits the making of copies
                or adaptation of a computer programme by the
                lawful possessor of the copy and the computer
                programme in order to utilize the public
                programme for the purpose for which it was
                supplied or to make backup copies purely as a
                temporary protection against loss, destruction
                or damage. Therefore, merely because the
                cellular operator has been permitted to take
                copies just for backup purposes, it cannot be
                said that it has acquired a copyright in the
                software.



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ITA 1034/2009                                               Page 101 of 174
                160. Clause 20.4(c) makes it mandatory for the
                cellular operator, while making copies of the
                software for backup purposes, to also mark the
                copied   software   with   copyright   or   other
                marking to show that the rights of the Assessee
                are reserved. This is one more indication that
                what the cellular operator acquired is not a
                copyright.

                161. Clause 20.4(d) says that the cellular
                operator cannot use the software for any other
                purpose than what is permitted and shall not
                also license or sell or in any manner alienate or
                part with its possession. This has to be read
                with Clause 20.5 which says that the license
                can be transferred, but only when the GSM
                system itself is sold by the cellular operator to
                a third party. This in a way shows that the
                software is actually part of the hardware and it
                has no use or value independent of it. This
                restriction placed on the cellular operator (not
                to license or sell the software) runs counter to
                Section 14(b)(ii) of the Copyright Act which
                permits a copyright holder to sell or let out on


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ITA 1034/2009                                               Page 102 of 174
                commercial rental the computer programme.
                For this reason also it cannot be said that JTM
                or any cellular operator acquired a copyright in
                the software.

                162. A conjoint reading of the terms of the
                supply contract and the provisions of the
                Copyright Act, 1957 clearly shows that the
                cellular operator cannot exploit the computer
                software    commercially   which          is    the      very
                essence of a copyright. In other words a holder
                of a copyright is permitted to exploit the
                copyright   commercially       and   if        he   is     not
                permitted to do so then what he has acquired
                cannot be considered as a copyright. In that
                case, it can only be said that he has acquired a
                copyrighted article. A small example may
                clarify the position. The purchaser of a book on
                income-tax acquires only a copyrighted article.
                On the other hand, a recording company which
                has recorded a vocalist has acquired the
                copyright   in   the   music    rendered            and     is,
                therefore, permitted to exploit the recording
                commercially. In this case the music recording


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ITA 1034/2009                                                            Page 103 of 174
                company     has    not   merely    acquired       a
                copyrighted article in the form of a recording,
                but has actually acquired a copyright to
                reproduce the music and exploit the same
                commercially. In the present case what JTM or
                any other cellular operator has acquired under
                the supply contract is only the copyrighted
                software, which is an article by itself and not
                any copyright therein.

                163. We may now briefly deal with the
                objections of Mr. G.C. Sharma, the learned
                senior   counsel   for   the   Department.     He
                contended that if a person owns a copyrighted
                article then he automatically has a right over
                the copyright also. With respect, this objection
                does not appear to us to be correct. Mr. Dastur
                filed an extract from Iyengar's Copyright Act
                (3rd Edition) edited by R.G. Chaturvedi. The
                following observations of the author are on the
                point:

                "(h) Copyright is distinct from the material
                object, copyrighted:


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ITA 1034/2009                                                Page 104 of 174
                It is an intangible incorporeal right in the
                nature of a privilege, quite independent of any
                material substance, such as a manuscript. The
                copyright owner may dispose of it on such
                terms as he may see fit. He has an individual
                right of exclusive enjoyment. The transfer of
                the manuscript does not, of itself, serve to
                transfer the copyright therein. The transfer of
                the ownership of a physical thing in which
                copyright exists gives to the purchaser the right
                to do with it (the physical thing) whatever he
                pleases, except the right to make copies and
                issue them to the public" (underline is ours).

                The above observations of the author show
                that one cannot have the copyright right
                without the copyrighted article but at the same
                time just because one has the copyrighted
                article, it does not follow that one has also the
                copyright in it. Mr. Sharma's objection cannot
                be accepted.

                164. It is not necessary, therefore, to consider
                the alternative argument of Mr. Dastur, namely,
                that even assuming that the Department is

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ITA 1034/2009                                               Page 105 of 174
                right in saying that if you have the copyrighted
                article, you also have the copyright right
                therein, still it would mean that the copyright
                rights are transferred (acquired by JTM) and it
                would not be a case of merely giving the right
                to use and consequently Article 13 of the DTAA
                would not apply. Mr. Dastur, however, was fair
                enough to concede that if the Department is
                right in saying that if you have the copyrighted
                article, you also have the copyrighted rights,
                then Clause (v) of Explanation 2 below Section
                9(1) of the Income-tax Act will apply because
                this clause ropes in "transfer of all or any
                rights" and is not restricted to "use" or "right
                to use", the copyright. However, he added that
                since the basic proposition of the Department
                has been demonstrated to be wrong, Clause (v)
                of Explanation 2 below Section 9(1) is not an
                impediment    to   accepting   the   assessee's
                contention.

                165. We may also usefully refer to the
                Commentary on the OECD Model Convention
                (dated 28.1.2003) which is of persuasive value


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ITA 1034/2009                                              Page 106 of 174
                and which throws considerable light on the
                character of the transaction and the treatment
                to be given to the payments for tax purposes.
                Paragraph 14 of the Commentary, a copy of
                which was filed in Paper book No. V is relevant:

                COMMENTARY ON ARTICLE 12 - PAPER BOOK V

                "14. In other types of transactions, the rights
                acquired in relation to the copyright are limited
                to those necessary to enable the user to
                operate the program, for example, where the
                transferee      is   granted    limited    rights   to
                reproduce the program. This would be the
                common situation in transactions for the
                acquisition of a program copy. The rights
                transferred in these cases are specific to the
                nature of computer programs. They allow the
                user to copy the program, for example onto
                the user's computer hard drive or for archival
                purposes. In this context, it is important to
                note that the protection afforded in relation to
                computer programs under copyright law may
                differ   from    country   to   country.    In   some
                countries the act of copying the program onto

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ITA 1034/2009                                                    Page 107 of 174
                the hard drive or random access memory of a
                computer would, without a license, constitute
                a breach of copyright. However, the copyright
                laws of many countries automatically grant this
                right   to    the    owner          of    software   which
                incorporates a computer program. Regardless
                of whether this right is granted under law or
                under a license agreement with the copyright
                holder,      copying        the     program      onto     the
                computer's      hard        drive    or   random     access
                memory or making an archival copy is an
                essential     step     in     utilizing    the    program.
                Therefore, rights in relation to these acts of
                copying, where they do no more than enable
                the effective operation of the program by the
                user, should be disregarded in analyzing the
                character of the transaction for tax purposes.
                Payments in these types of transactions would
                be   dealt    with     as     commercial         income     in
                accordance with Article 7."

                166. We may also usefully refer to the
                proposed amendments to the regulations of
                the Internal Revenue Service (IRS) in the USA.


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ITA 1034/2009                                                           Page 108 of 174
                Again these regulations may not be binding on
                us but they have a persuasive value and throw
                light on the question before us, namely the
                difference between a copyright right and a
                copyrighted article. These regulations have
                been placed at pages 136 to 157 of Paper book
                No. II. The actual regulations as well as the
                explanatory Note explaining the object and the
                purpose of the proposed regulations have also
                been given. In paragraph 1 of the Note titled
                "Background", it has been stated that the
                proposed regulations require that a transaction
                involving a computer programme may be
                treated as being one of the four possible
                categories.   Two   such   categories   are     the
                transfer of copyright rights and the transfer of
                a copyrighted article. The U.S. regulations
                distinguished between transfer of copyright
                rights and transfer of copyrighted articles
                based on the type of rights transferred to the
                transferee. Briefly stated, if the transferee
                acquires a copy of a computer programme but
                does not acquire any of the rights identified in
                certain sections (of the U.S. Regulations), the

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ITA 1034/2009                                                 Page 109 of 174
                regulation classified the transaction as the
                Transfer of a copyrighted article. Paragraph 3
                of the Explanatory Note says that if a transfer
                of a computer programme results in the
                transferee acquiring any one or more of the
                listed rights, it is a transfer of a copyright right.

                167. Paragraph 4 says that if a person acquires
                a copy of a computer programme but does not
                acquire any of the four listed copyright rights,
                he gets only a copyrighted article but no
                copyright.

                168. The actual regulations bring out the
                distinction very clearly between the copyright
                right and a copyrighted article. They also
                specify the four rights which, if acquired by the
                transferee, constitute him the owner of a
                copyright right. They are:

                (a) The right to make copies of the computer
                programme for purposes of distribution to the
                public by sale or other transfer of ownership,
                or by rental, lease, or lending.



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ITA 1034/2009                                                   Page 110 of 174
                (ii) The right to prepare derivative computer
                programmes     based   upon    the     copyrighted
                computer programme

                (iii) The right to make a public performance of
                the computer programme.

                (iv) The right to publically display the computer
                programme.

                169. A copyrighted article has been defined in
                the regulation (page 147 of the paper book) as
                including a copy of a computer programme
                from   which   the   work   can   be    perceived,
                reproduced or otherwise communicated either
                directly or with the aid of a machine or device.
                The copy of the programme may be fixed in the
                magnetic medium of a floppy disc or in the
                main memory or hard drive of a computer or in
                any other medium.

                170. So far as the transfer of copyrighted
                articles and copyright rights are concerned, the
                regulation goes on to say (page 148 of the
                paper book) that the question whether there


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ITA 1034/2009                                                Page 111 of 174
                was a transfer of a copyright right or only of a
                copyrighted article must be determined taking
                into account all the facts and circumstances of
                the case and the benefits and burden of
                ownership     which         have   been    transferred.
                Several examples have been given below these
                regulations to find out whether a particular
                transfer is a transfer of a copyright right or a
                transfer of a copyrighted article.

                171. The Commentary of "Charl P. du TOIT" on
                this question has been placed at pages 202 to
                204 of Paper book No. II. The Commentary is
                titled "Beneficial ownership of royalties in
                Bilateral Tax Treaties." He has opined that
                articles   such   as    Books      and    Records     are
                copyrighted articles and if they are sold, the
                user does not obtain the right to use any
                significant rights in the underlying copyright
                itself, which is what should determine the
                characterization       of    the   revenue    as     sale
                proceeds rather than royalties. He has further
                opined that consideration relating to sale of



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ITA 1034/2009                                                       Page 112 of 174
                software can amount to royalty only in limited
                circumstances.

                172. For the above reasons, we are of the view
                that the payment by the cellular operator is
                not for any copyright in the software but is
                only for the software as such as a copyrighted
                article. It follows that the payment cannot be
                considered as royalty within the meaning of
                Explanation       2 below Section      9(1)   of     the
                Income-tax Act or Article Article of the DTAA
                with Sweden.

                --------

                184. In view of the foregoing discussion, we
                hold       that   the   software   supplied   was       a
                copyrighted article and not a copyright right,
                and the payment received by the Assessee in
                respect of the software cannot be considered
                as royalty either under the Income-tax Act or
                the DTAA.

66.    Referring to the Commentary on the OECD Model

       Convention (dated 28.1.2003), which was considered


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ITA 1034/2009                                                      Page 113 of 174
       to be of persuasive value, the Tribunal noticed that the

       rights acquired in relation to the copyright are limited

       to those necessary to enable the user to operate the

       program, for example, where the transferee is granted

       limited rights to reproduce the program. This would be

       the      common   situation    in   transactions     for     the

       acquisition of a program copy. The rights transferred in

       these cases are specific to the nature of computer

       programs. They allow the user to copy the program,

       for example onto the user's computer hard drive or for

       archival purposes. Copying the program onto the

       computer's hard drive or random access memory or

       making an archival copy is an essential step in utilizing

       the program. Therefore, rights in relation to these acts

       of copying, where they do no more than enable the

       effective operation of the program by the user, should

       be disregarded in analyzing the character of the

       transaction for tax purposes. Payments in these types




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ITA 1034/2009                                             Page 114 of 174
       of transactions would be dealt with as commercial

       income in accordance with Article 7.


67.    The      Tribunal    further          referred   to        the     proposed

       amendments          to    the     regulations         of     the    Internal

       Revenue Service (IRS) in the USA not as binding but

       as having persuasive value and throwing light on the

       question i.e. the difference between a copyright right

       and a copyrighted article. The Tribunal noticed that the

       U.S. regulations distinguished between transfer of

       copyright rights and transfer of copyrighted articles

       based     on   the       type    of    rights    transferred         to    the

       transferee. Briefly stated, if the transferee acquires a

       copy of a computer programme but does not acquire

       any of the rights identified in certain sections (of the

       U.S.     Regulations),          the     regulation         classified      the

       transaction as the Transfer of a copyrighted article. If a

       transfer of a computer programme results in the

       transferee acquiring any one or more of the listed

       rights, it is a transfer of a copyright right. If a person

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ITA 1034/2009                                                           Page 115 of 174
       acquires a copy of a computer programme but does

       not acquire any of the four listed copyright rights, he

       gets only a copyrighted article but no copyright. The

       four rights being:

                (i) The right to make copies of the computer
                programme for purposes of distribution to
                the public by sale or other transfer of
                ownership, or by rental, lease, or lending.

                (ii) The right to prepare derivative computer
                programmes based upon the copyrighted
                computer programme

                (iii) The right to make a public performance
                of the computer programme.

                (iv)   The   right   to   publically   display     the
                computer programme.

68.    The Tribunal further noticed that a copyrighted article

       has been defined in the regulation as including a copy

       of a computer programme from which the work can be

       perceived, reproduced or otherwise communicated

       either directly or with the aid of a machine or device.


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ITA 1034/2009                                                    Page 116 of 174
       The copy of the programme may be fixed in the

       magnetic medium of a floppy disc or in the main

       memory or hard drive of a computer or in any other

       medium.


69.    The Tribunal has held and rightly so that the question

       whether there was a transfer of a copyright right or

       only of a copyrighted article must be determined ta king

       into account all the facts and circumstances of the

       case and the benefits and burden of ownership which

       have been transferred.


70.    The appeal filed by the Revenue against the Judgment

       of the Special Bench of the ITAT was dismissed by the

       High Court of Delhi in the case of DIT         V.   M/S NOKIA

       NETWORKS OY (2012) 253 CTR (D EL) 417. The bench

       approved of the findings of the Special Bench of the

       Tribunal in the Motorola case supra that Copyright is

       distinct from the material object, copyrighted. It is an

       intangible incorporeal right in the nature of a privilege,


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ITA 1034/2009                                              Page 117 of 174
       quite independent of any material substance, such as

       a manuscript. He has an individual right of exclusive

       enjoyment. The transfer of the manuscript does not, of

       itself, serve to transfer the copyright therein. The

       transfer of the ownership of a physical thing in which

       copyright exists gives to the purchaser the right to do

       with it (the physical thing) whatever he pleases, except

       the right to make copies and issue them to the public.

       Just because one has the copyrighted article, it does

       not follow that one has also the copyright in it.


71.    In the case of DIT V. ERICSSON A.B. (2012) 343 ITR

       470 (DEL), one issue that the Delhi High Court was

       considering was whether the consideration for supply

       of software was payment by way of royalty and hence

       assessable both under Section 9(1)(vi) and the Double

       Taxation     Avoidance      Agreement        between        the

       government of India and Sweden? The High Court

       relying on the Judgment of the Supreme Court of India

       in TATA CONSULTANCY SERVICES VS . STATE          OF   ANDHRA




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ITA 1034/2009                                            Page 118 of 174
       PRADESH , (2004) 271 ITR 401 (SC) , held that software

       incorporated on a media would be goods and liable to

       sales tax. The High Court has held as under:

                56.        A fortiorari when the assessee supplies
                the software which is incorporated on a CD, it
                has        supplied   tangible   property   and     the
                payment made by the cellular operator for
                acquiring such property cannot be regarded as
                a payment by way of royalty.
                ........

                59.        Be that as it may, in order to qualify as
                royalty payment, within the             meaning of
                section 9(1)(vi) and particularly clause (v) of
                Explanation 2          thereto, it is necessary to
                establish that there is transfer of all or any
                rights (including the granting of any licence) in
                respect of copyright of a literary,         artistic or
                scientific work. Section 2(o) of the Copyright
                Act makes it clear that a computer programme
                is to be regarded as a "literary work". Thus, in
                order to treat the consideration paid by the
                cellular operator as royalty, it is             to be


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ITA 1034/2009                                                     Page 119 of 174
                established that the cellular operator, by
                making such payment, obtains all or any of the
                copyright rights of such literary work. In the
                present case, this has not been established. It
                is not even the case of the Revenue that any
                right contemplated under section 14 of the
                Copyright    Act, 1957, stood vested in this
                cellular operator as a consequence of article 20
                of the supply contract. Distinction has to be
                made between the acquisition of a "copyright
                right" and a "copyrighted article".

                60. Mr. Dastur is right in this submission which
                is based on the commentary on the OECD
                Model Convention. Such a distinction has been
                accepted in a recent ruling of the Authority for
                Advance Ruling (AAR) in Dassault Systems KK
                229 CTR 125. We also find force in the
                submission of Mr. Dastur that even assuming
                the payment made by the cellular operator is
                regarded as a payment by way of royalty as
                defined in Explanation 2 below Section 9 (1)
                (vi), nevertheless, it can never be regarded as
                royalty within the meaning of the said term in


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ITA 1034/2009                                              Page 120 of 174
                article 13, para 3 of the DTAA. This is so
                because the definition in the DTAA is narrower
                than the definition in the Act. Article 13(3)
                brings within the ambit of the definition of
                royalty a payment made for the use of or the
                right to use a copyright of a literary work.
                Therefore, what is contemplated is a payment
                that is dependent upon user of the copyright
                and not a lump sum payment as is the position
                in the present case.

                We thus hold that payment received by the
                assessee was towards the title and GSM system
                of which software was an inseparable parts
                incapable of independent use and it was a
                contract for supply of goods. Therefore, no
                part of the payment therefore can be classified
                as payment towards royalty.

72.    The Delhi High Court further in ERICSSON        CASE   (SUPRA )

       further held that once it is held that payment in

       question is not royalty which would come within the

       mischief of clause (vi), the Explanation will have no

       application and that the question of applicability of the

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ITA 1034/2009                                             Page 121 of 174
       Explanation would arise only when payment is to be

       treated as "royalty" within the meaning of clause (vi) or

       "fee for technical services" as provided in clause (vii)

       of the Act.


73.    In the case of D ASSAULT SYSTEMS K. K., IN           RE   (2010)

       322 ITR 125 (AAR) the Authority on Advance Ruling

       has held as under:

                Passing on a right to use and facilitating the
                use of a product for which the owner has a
                copyright is not the same thing as transferring
                or assigning rights in relation to the copyright.
                The enjoyment of some or all the rights which
                the copyright owner has, is necessary to trigger
                the royalty definition. Viewed from this angle,
                a non-exclusive and non-transferable licence
                enabling the use of a copyrighted product
                cannot be construed as an authority to enjoy
                any or all of the enumerated rights ingrained in
                a copyright. Where the purpose of the licence
                or the transaction is only to establish access to
                the copyrighted product for internal business


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ITA 1034/2009                                              Page 122 of 174
                purpose, it would not be legally correct to state
                that the copyright itself has been transferred
                to any extent. It does not make any difference
                even if the computer programme passed on to
                the user is a highly specialized one. The parting
                of intellectual property rights inherent in and
                attached to the software product in favour of
                the licensee/customer is what is contemplated
                by the definition clause in the Act as well as the
                Treaty. As observed earlier, those rights are
                incorporated in section 14. Merely authorizing
                or enabling a customer to have the benefit of
                data or instructions contained therein without
                any   further   right   to   deal    with   them
                independently does not, in our view, amount
                to transfer of rights in relation to copyright or
                conferment of the right of using the copyright.
                However, where, for example, the owner of
                copyright over a literary work grants an
                exclusive licence to make out copies and
                distribute them within a specified territory, the
                grantee will practically step into the shoes of
                the owner/grantor and he enjoys the copyright
                to the extent of its grant to the exclusion of

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ITA 1034/2009                                               Page 123 of 174
                others. As the right attached to copyright is
                conveyed to such licencee, he has the authority
                to commercially deal with it. In case of
                infringement of copyright, he can maintain a
                suit to prevent it. Different considerations will
                arise if the grant is non-exclusive that too
                confined to the user purely for in-house or
                internal purpose. The transfer of rights in or
                over copyright or the conferment of the right
                of   use   of   copyright   implies   that     the
                transferee/licensee should acquire rights either
                in entirety or partially co-extensive with the
                owner/ transferor who divests himself of the
                rights he possesses pro tanto. That is what, in
                our view, follows from the language employed
                in the definition of "royalty" read with the
                provisions of the Copyright Act, viz., section 14
                and other complementary provisions.

                We may refer to one more aspect here. In the
                definition of royalty under the Act, the phrase
                "including the granting of a licence" is found.
                That does not mean that even a non-exclusive
                licence permitting user for inhouse purpose


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ITA 1034/2009                                                Page 124 of 174
                would be covered by that expression. Any and
                every licence is not what is contemplated. It
                should   take   colour   from    the   preceding
                expression "transfer of rights in respect of
                copyright". Apparently, grant of "licence" has
                been referred to in the definition to dispel the
                possible controversy a licence whatever be its
                nature, can be characterized as transfer.

74.    The Authority on Advance Ruling in the case of

       DASSAULT SYSTEMS K. K., IN          RE   (SUPRA) negated the

       contention of the revenue that the right permitting the

       licensee to make a copy of the programme by loading

       the programme on the hard disk of the computer

       amounted to assignment of a right in the copyright in

       terms of section 14 of the Copyright Act as under:

                It has been contended on behalf of the
                Revenue that the right to reproduce the work
                in any material form including the storing of it
                in any medium by electronic means (vide
                section 14(a)(i) of the Copyright Act) must be
                deemed to have been conveyed to the end-


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ITA 1034/2009                                               Page 125 of 174
                user. It is pointed out that a CD without right of
                reproduction on the hard disc is of no value to
                the   end-user   and    such   a   right    should
                necessarily be transferred to make it workable.
                It appears to us that the contention is based on
                a misunderstanding of the scope of right in
                sub-clause (i) of section 14(a). As stated in
                Copinger's treatise on Copyright, "the exclusive
                right to prevent copying or reproduction of a
                work is the most fundamental and historically
                oldest right of a copyright owner". We do not
                think that such a right has been passed on to
                the end-user by permitting him to download
                the computer programme and storing it in the
                computer for his own use. The copying/
                reproduction or storage is only incidental to
                the facility extended to the customer to make
                use of the copyrighted product for his internal
                business    purpose.   As   admitted       by     the
                Revenue's    representative,   that   process       is
                necessary to make the programme functional
                and to have access to it and is qualitatively
                different from the right contemplated by the
                said provision because it is only integral to the

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ITA 1034/2009                                                   Page 126 of 174
                use of copyrighted product. Apart from such
                incidental facility, the customer has no right to
                deal with the product just as the owner would
                be in a position to do. In so far as the licensed
                material reproduced or stored is confined to
                the four corners of its business establishment,
                that too on a non-exclusive basis, the right
                referred to in sub-clause (i) of section 14(a)
                would be wholly out of place. Otherwise, in
                respect of even off-the-shelf software available
                in the market, it can be very well said that the
                right of reproduction which is a facet of
                copyright vested with the owner is passed on
                to the customer. Such an inference leads to
                unintended and irrational results. We may in
                this context refer to section 52(aa) of the
                Copyright Act (extracted supra) which makes it
                clear that "the making of copies or adaptation"
                of a computer programme by the lawful
                possessor of a copy of such programme, from
                such copy (i) in order to utilize the computer
                program, for the purpose for which it was
                supplied or (ii) to make back up copies purely
                as   a   temporary   protection   against   loss,

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ITA 1034/2009                                               Page 127 of 174
                destruction, or damage in order to utilize the
                computer programme for the purpose of which
                it   was     supplied"     will      not   constitute
                infringement      of    copyright.     Consequently,
                customization or adaptation, irrespective of
                the degree, will not constitute "infringement"
                as long as it is to ensure the utilization of the
                computer programme for the purpose for
                which it was supplied. Once there is no
                infringement, it is not possible to hold that
                there is transfer or licensing of "copyright" as
                defined in the Copyright Act and as understood
                in common law. This is because, as pointed out
                earlier, copyright is a negative right in the
                sense that it is a right prohibiting someone else
                to do an act, without authorization of the same,
                by the owner.

                It   seems   to    us    that     reproduction    and
                adaptation envisaged by section 14(a)(i) and (vi)
                can contextually mean only reproduction and
                adaptation for the purpose of commercial
                exploitation. Copyright being a negative right
                (in the sense explained in paragraph 9 supra), it


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ITA 1034/2009                                                    Page 128 of 174
                would only be appropriate and proper to test it
                in terms of infringement. What has been
                excluded     under     section    52(aa)   is     not
                commercial exploitation, but only utilizing the
                copyrighted product for one's own use. The
                exclusion should be given due meaning and
                effect;   otherwise,   section    52(aa)   will    be
                practically redundant. In fact, as the law now
                stands, the owner need not necessarily grant
                licence for mere reproduction or adaptation of
                work for one's own use. Even without such
                licence, the buyer of product cannot be said to
                have infringed the owner's copyright. When
                the infringement is ruled out, it would be
                difficult to reach the conclusion that the
                buyer/licensee of product has acquired a
                copyright therein.

75.    The Authority on Advance Ruling in the case of

       DASSAULT SYSTEMS K. K., IN                 RE   (SUPRA) further

       approved the reasoning of the Special Bench of

       Income-tax         Appellate    Tribunal   in   MOTOROLA INC.

       (SUPRA) and noticed that the said decision has been

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ITA 1034/2009                                                   Page 129 of 174
       followed      in   several    decisions      of   the     Income-tax

       Appellate Tribunal till date.


76.    The      Authority    on     Advance       Ruling    following      the

       decision in the DASSAULT CASE (SUPRA ) in the case of

       GEOQUEST           SYSTEMS    B.V.    V.    DIT     (INTERNATIONAL

       TAXATION-I) [(2010)234CTR(AAR)73] held as under:

                9. The revenue has sought to place reliance on
                the proviso to section 9(1)(vi) and sub-section
                (1A) of section 115A in order to contend that
                the Act contemplated charging of 'royalty' for
                authorization to use computer software as
                such and it is not necessary that the copyright
                therein should be specifically transferred. We
                are not impressed by this argument. The
                expression   'computer      software'      has   been
                defined by Explanation 3 to section 9(1)(vi) for
                the purpose of the second proviso to the said
                clause. The computer software is defined to
                mean any computer programme recorded on
                any disc, tape, perforated media or other
                information storage device and includes any
                such programme or any customized electronic

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ITA 1034/2009                                                    Page 130 of 174
                data. Under the second proviso the income by
                way   of    'royalty'   consisting   of    lump    sum
                payment made by a resident for the transfer of
                all or any rights (including the grant of licence)
                in respect of the computer software by a non-
                resident manufacturer along with a computer
                based equipment under a scheme approved as
                per the 1986 Policy on computer software
                export, software development and training, is
                excluded from the purview of 'royalty' clause.
                It does not, however, mean that wherever
                computer software is transferred on outright
                sale basis or is leased or licensed, it would
                become royalty income. Whether or not the
                income is in the nature of royalty has to be
                judged     with   reference    to    the   exhaustive
                definition in Explanation 2. In this context, sub-
                clause (v) of Explanation 2 which has been
                referred to by both sides become relevant. It is
                in the light of the language of that clause one
                has to see whether the income in question
                ought to be treated as 'royalty'. The transfer of
                rights envisaged by sub-clause (v) should be in
                respect of the 'copyright' among others. Mere

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ITA 1034/2009                                                     Page 131 of 174
                transfer of computer software dehors any
                copyright associated with it does not fall within
                the ambit of the said clause (v). That is what
                has been held in the two rulings referred to
                earlier.

77.    The Supreme Court of India in TATA CONSULTANCY

       CASE     (SUPRA) was considering the question whether

       the sale of software was sale of goods and thus

       exigible to sales tax. The Supreme Court held that

       software may be intellectual property and contained on

       a medium was a marketable commodity and an object

       of trade and commerce. The Supreme Court of India

       held as under:


                "15. Sorabjee submitted that the question as
                to whether software is tangible or intangible
                property has been considered by the American
                Courts. He fairly pointed out that in America
                there is a difference of opinion amongst the
                various Courts. He submitted that, however,
                the majority of the Courts have held that a
                software is an intangible property. He showed

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ITA 1034/2009                                              Page 132 of 174
                to the Court a number of American Judgments,
                viz., the cases of Commerce Union Bank v.
                Tidwell 538 S.W.2d 405; State of Alabama v.
                Central Computer Services. INC 349 So. 2d
                1156; The First National Bank of Fort Worth v.
                Bob Bullock 584 S.W.2d 548; First National
                Bank of Springfield v. Department of Revenue
                421 NE2d 175; Compuserve, INC. v. Lindley 535
                N.E. 2d 360 and Northeast Datacom, Inc., et al
                v. City of Wallingford 563        A2d 688. In these
                cases,   it   has   been   held    that   'computer
                software' is tangible personal property. The
                reasoning for arriving at this conclusion is
                basically that the information contained in the
                software programs can be introduced into the
                user's computer by several different methods,
                namely, (a) it could be programmed manually
                by the originator of the program at the location
                of the user's computer, working from his own
                instructions or (b) it could be programmed by a
                remote programming terminal located miles
                away from the user's computer, with the input
                information being transmitted by telephone; or
                (c) more commonly the computer could be

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ITA 1034/2009                                                 Page 133 of 174
                programmed by use of punch cards, magnetic
                tapes   or   discs,   containing   the   program
                developed by the vendor. It has been noticed
                that usually the vendor will also provide
                manuals, services and consultation designed to
                instruct the user's employees in the installation
                and utilization of the supplied program. It has
                been held that even though the intellectual
                process is embodied in a tangible and physical
                manner, that is on the punch cards, magnetic
                tapes, etc. the logic or intelligence of the
                program remains intangible property. It is held
                that it is this intangible property right which is
                acquired when computer software is purchased
                or leased. It has been held that what is created
                and sold is information and the magnetic tapes
                or the discs are only the means of transmitting
                these intellectual creations from the originator
                to the user. It has been held that the same
                information could have been transmitted from
                the originator to the user by way of telephone
                lines or fed directly into the user's computer by
                the originator of the programme and that as
                there would be no tax in those cases merely

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ITA 1034/2009                                               Page 134 of 174
                because the method of transmission is by
                means of a tape or a disc, it does not constitute
                purchase of tangible personal property and the
                same remains intangible personal property. It
                has been held that what the customer paid for
                is the intangible knowledge which cannot be
                subjected to the personal property tax. In
                these cases, difference is sought to be made
                between         purchase     of     a    book,    music
                cassette/video      or     film    and   purchase        of
                software on the following lines: "When one
                buys a video cassette recording, a book, sheet
                music or a musical recording, one acquires a
                limited right to use and enjoy the material's
                content. One does not acquire, however, all
                that the owner has to sell. These additional
                incidents of ownership include the right to
                produce and sell more copies, the right to
                change the underlying work, the right to
                license its use to other and the right to transfer
                the copyright itself. It is these incidents of the
                intellectual,     intangible      competent      of     the
                software    property        that    Wallingford         has
                impermissibly assessed as tangible property by

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ITA 1034/2009                                                         Page 135 of 174
                linking these incorporeal incidents with the
                tangible medium in which the software is
                stored and transmitted."

                16. It has been fairly brought to the attention
                of the Court that many other American Courts
                have taken a different view. Some of those
                cases are South Central Bell Telephone Co. v.
                Sidney   J.   Barthelemy              643    So.2d     1240;
                Comptroller of the Treasury v. Equitable Trust
                Company 464 A.2d 248; Chittenden Trust Co. v.
                Commissioner        of        Taxes    465    A.2d     1100;
                University      Computing                   Company         v.
                Commissioner of Revenue for the State of
                Tennessee     677        S.W.2d       445     and    Hasbro
                Industries,   INC.       v.    John    H.    Norberg,     Tax
                Administrator 487 A.2d 124. In these cases, the
                Courts have held that when stored on magnetic
                tape, disc or computer chip, this software or
                set of instructions is physically manifested in
                machine readable form by arranging electrons,
                by use of an electric current, to create either a
                magnetized     or    unmagnetized             space.     This
                machine readable language or code is the


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ITA 1034/2009                                                           Page 136 of 174
                physical manifestation of the information in
                binary form. It has been noticed that at least
                three program copies exist in a software
                transaction: (i) an original, (ii) a duplicate, and
                (iii) the buyer's final copy on a memory device.
                It has been noticed that the program is
                developed in the seller's computer then the
                seller duplicates the program copy on software
                and transports the duplicates to the buyer's
                computer. The duplicate is read into the
                buyer's computer and copied on a memory
                device. It has been held that the software is
                not merely knowledge, but rather is knowledge
                recorded in a physical form having a physical
                existence, taking up space on a tape, disc or
                hard drive, making physical things happen and
                can be perceived by the senses. It has been
                held that the purchaser does not receive mere
                knowledge but receives an arrangement of
                matter which makes his or her computer
                perform a desired function. It has been held
                that this arrangement of matter recorded on
                tangible medium constitutes a corporeal body.
                It has been held that a software recorded in

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ITA 1034/2009                                                Page 137 of 174
                physical form becomes inextricably intertwined
                with, or part and parcel of the corporeal object
                upon which it is recorded, be that a disk, tape,
                hard drive, or other device. It has been held
                that the fact that the information can be
                transferred and then physically recorded on
                another medium does not make computer
                software any different from any other type of
                recorded information that can be transferred
                to another medium such as film, video tape,
                audio tape or books. It has been held that by
                sale   of     the   software      programme            the
                incorporeal    right   to   the   software      is     not
                transferred. It is held that the incorporeal right
                to software is the copyright which remains
                with the originator. What is sold is a copy of
                the software. It is held that the original
                copyright version is not the one which operates
                the computer of the customer but the physical
                copy   of   that    software      which   has        been
                transferred to the buyer. It has been held that
                when one buys a copy of a copyrighted novel in
                a bookstore or recording of a copyrighted song
                in a record store, one only acquires ownership

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ITA 1034/2009                                                        Page 138 of 174
                of that particular copy of the novel or song but
                not the intellectual property in the novel or
                song.

                .......

                19. Thus this Court has held that the term
                "goods", for the purposes of sales tax, cannot
                be given a narrow meaning. It has been held
                that properties which are capable of being
                abstracted,    consumed       and   used    and/or
                transmitted, transferred, delivered, stored or
                possessed etc. are "goods" for the purposes of
                sales tax. The submission of Mr. Sorabjee that
                this authority is not of any assistance as a
                software is different from electricity and that
                software is intellectual incorporeal property
                whereas electricity is not, cannot be accepted.
                In India the test, to determine whether a
                property is "goods", for purposes of sales tax,
                is not whether the property is tangible or
                intangible or incorporeal. The test is whether
                the concerned item is capable of abstraction,
                consumption and use and whether it can be
                transmitted,   transferred,    delivered,   stored,

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ITA 1034/2009                                                 Page 139 of 174
                possessed etc. Admittedly in the case of
                software, both canned and uncanned, all of
                these are possible. "

78.    The Supreme Court of India in TATA CONSULTANCY

       CASE      (SUPRA)     referred    to   the   Judgment   of    the

       Supreme Court in ASSOCIATED CEMENT COMPANIES LTD .

       VS C OMMISSIONER        OF    C USTOMS (2001) 4 SCC 593 as

       under:


                43. Similar would be the position in the case of
                a programme of any kind loaded on a disc or a
                floppy. For example in the case of music the
                value of a popular music cassette is several
                times more than the value of a blank cassette.
                However, if a prerecorded music cassette or a
                popular film or a musical score is imported into
                India duty will necessarily have to be charged
                on the value of the final product. In this behalf
                we may note that in State Bank of India v.
                Collector of Customs MANU/SC/0017/2000 :
                (2000) 1 SCC 727 the Bank had, under an
                agreement     with      the   foreign   company,


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ITA 1034/2009                                              Page 140 of 174
                imported a computer software and manuals,
                the total value of which was US Dollars
                4,084,475. The Bank filed an application for
                refund of customs duty on the ground that the
                basic cost of software was US Dollars 401.047.
                While the rest of the amount of US Dollars
                3,683,428 was payable only as a licence fee for
                its right to use the software for the Bank
                countrywide. The claim for the refund of the
                customs duty paid on the aforesaid amount of
                US Dollars 3,683,428 was not accepted by this
                Court   as   in   its   opinion,   on   a   correct
                interpretation of Section 14 read with the
                Rules, duty was payable on the transaction
                value determined therein, and as per Rule 9 in
                determining the transaction value there has to
                be added to the price actually paid or payable
                for the imported goods, royalties and the
                licence fee for which the buyer is required to
                pay, directly or indirectly, as a condition of sale
                of goods to the extent that such royalties and
                fees are not included in the price actually paid
                or payable. This clearly goes to show that when
                technical material is supplied whether in the

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ITA 1034/2009                                                 Page 141 of 174
                form of drawings or manuals the same are
                goods liable to customs duty on the transaction
                value in respect thereof.

                44. It is a misconception to contend that what
                is being taxed is intellectual input. What is
                being taxed under the Customs Act read with
                the Customs Tariff Act and                the Customs
                Valuation Rules is not the input alone but
                goods whose value has been enhanced by the
                said inputs. The final product at the time of
                import     is     either    the   magazine     or      the
                encyclopaedia or the engineering drawings as
                the case may be. There is no scope for splitting
                the engineering drawing or the encyclopaedia
                into intellectual input on the one hand and the
                paper on which it is scribed on the other. For
                example, paintings are also to be taxed.
                Valuable        paintings   are   worth    millions.    A
                painting    or     a   portrait   may     be   specially
                commissioned or an article may be tailormade.
                This aspect is irrelevant since what is taxed is
                the final product as defined and it will be an
                absurdity to contend that the value for the


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ITA 1034/2009                                                       Page 142 of 174
                purposes of duty ought to be the cost of the
                canvas and the oil paint even though the
                composite product, i.e., the painting, is worth
                millions.

                ......

                48. The above view, in our view, appears to be
                logical   and    also   in   consonance      with     the
                Customs Act. Similarly in Advent Systems Ltd. v.
                Unisys Corporation 1925 F 2d 670 it was
                contended before the Court in the United
                States    that   software     referred    to   in     the
                agreement        between     the   parties     was       a
                "product" and not a "good" but intellectual
                property outside the ambit of the Uniform
                Commercial Code. In the said Code, goods
                were defined as "all things (including specially
                manufactured goods) which are moveable at
                the time of the identification for sale". Holding
                that computer software was a "good" the
                Court held as follows : "Computer programs
                are the product of an intellectual process, but
                once implanted in a medium they are widely
                distributed to computer owners. An analogy

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ITA 1034/2009                                                       Page 143 of 174
                can be drawn to a compact-disc recording of an
                orchestral rendition. The music is produced by
                the artistry of musicians and in itself is not a
                'good',   but     when transferred       to a     laser-
                readable        disc   it   becomes        a     readily
                merchantable commodity. Similarly, when a
                professor delivers a lecture, it is not a good,
                but, when transcribed as a book, it becomes a
                good. That a computer program may be
                copyrightable as intellectual property does not
                alter the fact that once in the form of a floppy
                disc or other medium, the program is tangible,
                moveable and available in the marketplace.
                The fact that some programs may be tailored
                for specific purposes need not alter their status
                as 'goods' because the Code definition includes
                'specially manufactured goods'."

79.    The       Supreme          Court     of   India     in     TATA

       CONSULTANCY          CASE       (SUPRA)   further       held   as

       under:

                25. To be noted that this authority is directly
                dealing with the question in issue. Even though


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ITA 1034/2009                                                     Page 144 of 174
                the definition of the term "goods" in the
                Customs Act is not as wide or exhaustive as the
                definition of the term "goods" in the said Act, it
                has    still     been   held      that    the     intellectual
                property when it is put on a media becomes
                goods.
                ....
                27. In our view, the term "goods" as used in
                Article 366(12) of the Constitution of India and
                as defined under the said Act are very wide and
                include        all   types   of    movable        properties,
                whether         those   properties        be    tangible    or
                intangible. We are in complete agreement with
                the    observations          made    by    this    Court     in
                Associated Cement Companies Ltd. (supra). A
                software programme may consist of various
                commands which enable the computer to
                perform a designated task. The copyright in
                that     programme           may    remain        with     the
                originator of the programme. But the moment
                copies are made and marketed, it becomes
                goods, which are susceptible to sales tax. Even
                intellectual property, once it is put on to a
                media, whether it be in the form of books or

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ITA 1034/2009                                                            Page 145 of 174
                canvas (In case of painting) or computer discs
                or cassettes, and marketed would become
                "goods". We see no difference between a sale
                of a software programme on a CD/floppy disc
                from a sale of music on a cassette/CD or a sale
                of a film on a video cassette/CD. In all such
                cases,     the    intellectual    property    has   been
                incorporated on a media for purposes of
                transfer. Sale is not just of the media which by
                itself has very little value. The software and the
                media cannot be split up. What the buyer
                purchases and pays for is not the disc or the CD.
                As in the case of paintings or books or music or
                films the buyer is purchasing the intellectual
                property and not the media i.e. the paper or
                cassette or disc or CD. Thus a transaction sale
                of computer software is clearly a sale of
                "goods" within the meaning of the term as
                defined in the said Act. The term "all materials,
                articles    and        commodities"     includes    both
                tangible and intangible/incorporeal property
                which is capable of abstraction, consumption
                and   use        and    which    can   be    transmitted,
                transferred, delivered, stored, possessed etc.

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ITA 1034/2009                                                       Page 146 of 174
                The software programmes             have all   these
                attributes.

80.    S.B. Sinha J. in TATA CONSULTANCY                    CASE   (SUPRA )

       concurring with the decision of the Majority referred to

       the Judgment in the case of South Central Bell

       Telephone Co. v. Sidney J. Barthelemny, et al. [643

       So. 2d 1240 : 36 A.L.R. 5th 689], the Supreme Court

       of Louisiana as under:

                26. The court, however, noticed that the shift
                in the trend was not uniform. Having regard to
                the fact that the computer software became
                the knowledge and understanding and upon
                discussing    the    characteristics   of   computer
                software and classification thereof as tangible
                or intangible under Louisiana law, it was held:

                      "The software itself, i.e. the physical copy,
                      is not merely a right or an idea to be
                      comprehended by the understanding.
                      The purchaser of computer software
                      neither       desires   nor   receives   mere
                      knowledge, but rather receives a certain


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ITA 1034/2009                                                  Page 147 of 174
                  arrangement of matter that will make his
                  or her computer perform a desired
                  function. This arrangement of matter,
                  physically recorded on some tangible
                  medium, constitutes a corporeal body.

                  We agree with Bell and the court of
                  appeal that the form of the delivery of
                  the software-magnetic tape or electronic
                  transfer via modem- is of no relevance.
                  However, we disagree with Bell and the
                  court of appeal that the essence or real
                  object of the transaction was intangible
                  property . That the software can be
                  transferred to various media i.e. from
                  tape to disc, or tape to hard drive, or
                  even that it can be transferred over the
                  telephone lines, does not take away from
                  the fact that the software was ultimately
                  recorded and stored in physical form
                  upon a physical object. See Crockett,
                  supra, at 872-74; Shontz, at 168-70;
                  Cowdrey, supra, at 188-90. As the court
                  of appeal explained, and as Bell readily


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ITA 1034/2009                                            Page 148 of 174
                  admits, the programs cannot be utilized
                  by Bell until they have been recorded
                  into   the    memory        of        the    electronic
                  telephone switch. 93-1072, at p. 6, 631
                  So.2d at 1342. The                   essence of the
                  transaction was not merely to obtain the
                  intangible "knowledge" or "information",
                  but    rather,     was     to    obtain      recorded
                  knowledge         stored    in        some    sort   of
                  physical form that Bell's computers could
                  use. Recorded as such, the software is
                  not merely an incorporeal idea to be
                  comprehended, and would be of no use
                  if it were. Rather, the software is given
                  physical     existence          to    make     certain
                  desired physical things happen.

                  One cannot escape the fact that software,
                  recorded     in    physical          form,   becomes
                  inextricably intertwined with, or part and
                  parcel of the corporeal object upon
                  which it is recorded , be that a disc, tape,
                  hard drive, or other device. Crockett,
                  supra, at 871072; Cowdrey, Supre, at


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ITA 1034/2009                                                      Page 149 of 174
                      188-90. That the information can be
                      transferred and then physically recorded
                      on another medium is of no moment,
                      and does not make computer software
                      any different than any other type of
                      recorded    information   that   can       be
                      transferred to another medium such as
                      film, video tape, audio tape, or books."

                It was further opined :

                      "It is now common knowledge that books,
                      music, and even movies or other audio/visual
                      combinations can be copied from one medium
                      to another. They are also all available on
                      computer in such forms as floppy disc, tape,
                      and CD-ROM. Such movies, books, music,
                      etc .can all be delivered by and/or copied from
                      one medium to another, including electrical
                      impulses with the use of a modem. Assuming
                      there is sufficient memory space available in
                      the computer hard disc drive such movies,
                      books, music, etc .can also be recorded into
                      the permanent memory of the computer such
                      as was done with the software in this case. 93-

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ITA 1034/2009                                                Page 150 of 174
                      1072, at p. 4, 5. 631 So.2d at 1346-47
                      (dissenting opinion). See also Shontz. Supra, at
                      168-170;    Harris, supra,   at    187.    That     the
                      information,    knowledge,    story,       or     idea,
                      physically manifested in recorded form, can be
                      transferred from one medium to 15 another
                      does not affect the nature of that physical
                      manifestation as corporeal, or tangible. Shontz,
                      supra, at 168-170. Likewise, that the software
                      can be transferred from 1248 one type of
                      physical recordation, e.g., tape, to another
                      type, e.g., disk or hard drive, does not alter the
                      nature of the software, Shontz, supra, at 168-
                      170; it still has corporeal qualities and is
                      inextricably   intertwined   with    a     corporeal
                      object. The software must be stored in physical
                      form on some tangible object somewhere..."

                27. Reversing the findings of the court below that the
                computer software constitutes intellectual property,
                it was opined :

                      "In   sum,     once    the   "information"           or
                      "knowledge"     is   transformed    into     physical
                      existence and recorded in physical form, it is

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ITA 1034/2009                                                   Page 151 of 174
                    corporeal property. The physical recordation of
                    this software is not an incorporeal right to be
                    comprehended. therefore we hold that the
                    switching   system      software   and    the    data
                    processing software involved here is tangible
                    personal property and thus is taxable by the
                    City of New Orleans."

81.    The      Supreme    Court    in    TATA C ONSULTANCY         CASE

       (SUPRA) have thus laid down that Computer programs

       are the product of an intellectual process, but once

       implanted in a medium they are widely distributed to

       computer owners. That a computer program may be

       copyrightable as intellectual property does not alter

       the fact that once in the form of a floppy disc or other

       medium,     the    program    is    tangible,   moveable       and

       available in the marketplace.


82.    The Supreme Court has further held that a software

       programme may consist of various commands which

       enable the computer to perform a designated task.

       The copyright in that programme may remain with the

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ITA 1034/2009                                                Page 152 of 174
       originator of the programme. But the moment copies

       are made and marketed, it becomes goods, which are

       susceptible to sales tax. Even intellectual property,

       once it is put on to a media, whether it be in the form

       of books or canvas (In case of painting) or computer

       discs or cassettes, and marketed would become

       "goods". There is no difference between a sale of a

       software programme on a CD/floppy disc from a sale

       of music on a cassette/CD or a sale of a film on a

       video cassette/CD. In all such cases, the intellectual

       property     has   been   incorporated       on   a   media     for

       purposes of transfer. Sale is not just of the media

       which by itself has very little value. The software and

       the      media   cannot   be   split   up.   What     the   buyer

       purchases and pays for is not the disc or the CD. As in

       the case of paintings or books or music or films the

       buyer is purchasing the intellectual property and not

       the media i.e. the paper or cassette or disc or CD. The

       software itself, i.e. the physical copy, is not merely a


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ITA 1034/2009                                                Page 153 of 174
       right    or    an     idea    to    be    comprehended          by   the

       understanding.


83.    It has been further held that the purchaser of computer

       software neither desires nor receives mere knowledge,

       but rather receives a certain arrangement of matter

       that will make his or her computer perform a desired

       function.      This    arrangement          of   matter,   physically

       recorded on some tangible medium, constitutes a

       corporeal body. The form of the delivery of the

       software-magnetic            tape    or    electronic    transfer    via

       modem- is of no relevance. That the software can be

       transferred to various media i.e. from tape to disc, or

       tape to hard drive, or even that it can be transferred

       over the telephone lines, does not take away from the

       fact that the software was ultimately recorded and

       stored    in    physical      form       upon    a   physical   object.

       Recorded as such, the software is not merely an

       incorporeal idea to be comprehended, and would be of

       no use if it were. Rather, the software is given physical

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ITA 1034/2009                                                     Page 154 of 174
       existence to make certain desired physical things

       happen. One cannot escape the fact that software,

       recorded       in   physical    form,       becomes      inextricably

       intertwined with, or part and parcel of the corporeal

       object upon which it is recorded , be that a disc, tape,

       hard drive, or other device. That the information can

       be       transferred   and     then    physically       recorded        on

       another medium is of no moment, and does not make

       computer software any different than any other type of

       recorded       information     that    can    be    transferred          to

       another medium such as film, video tape, audio tape,

       or books.       It is now common knowledge that books,

       music,       and    even     movies     or    other      audio/visual

       combinations can be copied from one medium to

       another. They are also all available on computer in

       such forms as floppy disc, tape, and CD-ROM. Such

       movies, books, music, etc. can all be delivered by

       and/or copied from one medium to another, including

       electrical     impulses      with     the    use   of    a     modem.


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ITA 1034/2009                                                       Page 155 of 174
       Assuming there is sufficient memory space available

       in the computer hard disc drive such movies, books,

       music, etc. can also be recorded into the permanent

       memory      of    the     computer.     That   the    information,

       knowledge, story, or idea, physically manifested in

       recorded form, can be transferred from one medium to

       another does not affect the nature of that physical

       manifestation as corporeal, or tangible. Likewise, that

       the software can be transferred from one type of

       physical recordation, e.g., tape, to another type, e.g.,

       disk or hard drive, does not alter the nature of the

       software,    it   still    has   corporeal     qualities   and     is

       inextricably intertwined with a corporeal object. The

       software must be stored in physical form on some

       tangible    object        somewhere.     In    sum,    once      the

       "information"     or      "knowledge"    is    transformed       into

       physical existence and recorded in physical form, it is

       corporeal property. The physical recordation of this




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ITA 1034/2009                                                 Page 156 of 174
       software       is    not   an    incorporeal     right     to     be

       comprehended.


84.    To further elucidate the nature of the transaction in the

       case of the Assessee it is necessary to examine some

       of the clauses of the Licensing software agreement

       entered into by the Assessee with its customers:


       INFRASOFT LICENCE AGREEMENT.

       2.       GRANT, SUPPLY AND USE OF LICENCE

                a)    Infrasoft grants Licensee a non-exclusive,
                non-transferable licence to use the software in
                accordance    with   this   Agreement   and     the
                Infrasoft   Licence Schedule.   The licence is
                perpetual unless identified as being for a
                specified term in the Infrasoft Licence Schedule.

                b)    Any third party software incorporated in
                the software is licensed only for use with the
                software.

                c)    Infrasoft will supply one copy of the
                software for each site and, when applicable,

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ITA 1034/2009                                                 Page 157 of 174
                one set of support information to the Licensee.
                Licensee shall pay Infrasoft a fee for additional
                copies of any printed support information
                supplied by Infrasoft.

                d)    Liecensee may make one copy of the
                software and associated support information
                for backup purposes, provided that the copy
                shall include Infrasoft's copyright and other
                proprietary notices. All copies of the Software
                shall be the exclusive property of Infrasoft.

                e)    The     Software    includes     a   licence
                authorisation device, which restricts the use of
                the Software as specified in the Infrasoft
                Licence Schedule.

                f)    The Software shall be used only for
                Licensee's own business as defined within the
                Infrasoft   Licence   Schedule   and   shall    not,
                without prior written consent from Infrasoft:

                (i)   be loaned, rented, sold, sublicensed or
                      transferred to any third party




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ITA 1034/2009                                                  Page 158 of 174
                (ii)    used    by   any   parent,      subsidiary    or
                        affiliated entity of Licensee

                (iii)   Used for the operation of a service
                        bureau or for data processing

                g)      If Licensee was granted an educational
                licence, as identified on the Infrasoft Licence
                Schedule, the Software may only be used for
                instruction or research purposes and not for
                any commercial purposes.

                h)      Licensee     may   not   copy,     decompile,
                disassemble or reverse-engineer the Software
                without     Infrasoft's    written   consen t.       The
                Licensee's rights shall not be restricted by this
                Clause 2(h) to the extent that local law grants
                Licensee a right to do so for the purpose of
                achieving interoperability with other software
                and in addition thereto Infrasoft undertakes to
                make information relating to interoperability
                available      to    Licensee    subject    to   such
                reasonable conditions as Infrasoft may from
                time to time impose including a reasonable fee
                for doing so. To ensure Licensee receives the

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ITA 1034/2009                                                    Page 159 of 174
                appropriate information, Licensee must first
                give Infrasoft sufficient details of its objectives
                and the other software concerned. Requests
                for the appropriate information should be
                directed to the Vice president Technical of
                Infrasoft.

       3.       LICENCE FEES, PAYMENT AND TAXES

                a)    Licensee shall pay Infrasoft a licence fee
                for the use of the Software as agreed in the
                order.   Infrasoft   confirms   that   where     the
                Licensee has purchased the Software through
                an authorised reseller of the Software the
                Licensee shall owe no license fees to Infrasoft
                where the Licensee has made payment of the
                licence fees to the authorised reseller.

                b)    All licence fees are exclusive of and net
                of any taxes, duties or other such additional
                sums including, but without prejudice to the
                foregoing generality, value added//purchase
                tax, excise tax (tax on sales, property or use),
                import or other duties and whether levied in
                respect of this Agreement, the Software its use

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ITA 1034/2009                                                  Page 160 of 174
                or otherwise. All such taxes shall be the
                responsibility of the Licensee and shall be
                payable in addition to the licence fee.

                c)       Infrasoft advises the Licensee that the
                Software contains a mechanism which Infrasoft
                may activate to deny the Licensee use of the
                Software in the event that the Licensee is in
                breach     of   payment   terms   or   any   other
                provisions of this Agreement.

       4.       ......

       5.       OWNERSHIP, INTELLECTUAL PROPERTY AND
                INDEMNITY

                a)       All copyrights and intellectual property
                rights in and to the Software, and copies made
                by Licensee, are owned by or duly licensed to
                Infrasoft. Infrasoft warrants that it has the
                power to grant the licence rights contained in
                this Agreement.

85.    The Licensing Agreement shows that the license is

       non-exclusive, non-transferable and the software has



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ITA 1034/2009                                                Page 161 of 174
       to be uses in accordance with the Agreement. Only

       one copy of the software is being supplied for each

       site. The licensee is permitted to make only one copy

       of the software and associated support information

       and that also for backup purposes. It is also stipulated

       that     the   copy   so   made   shall   include   Infrasofts

       copyright and other proprietary notices. All copies of

       the Software are the exclusive property of Infrasoft.

       The Software includes a licence authorisation device,

       which restricts the use of the Software. The software is

       to be used only for Licensees own business as

       defined within the Infrasoft Licence Schedule. Without

       the consent of the Assessee the software cannot be

       loaned, rented, sold, sublicensed or transferred to any

       third party or used by any parent, subsidiary or

       affiliated entity of Licensee or used for the operation of

       a service bureau or for data processing. The Licensee

       is further restricted from making copies, decompile,

       disassemble or reverse-engineer the Software without


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ITA 1034/2009                                              Page 162 of 174
       Infrasofts written consent. The Software contains a

       mechanism which Infrasoft may activate to deny the

       Licensee use of the Software in the event that the

       Licensee is in breach of payment terms or any other

       provisions      of    this   Agreement.     All   copyrights    and

       intellectual property rights in and to the Software, and

       copies made by Licensee, are owned by or duly

       licensed to Infrasoft.


86.    The Licensing Agreement shows that the license is

       non-exclusive, non-transferable and the software has

       to be uses in accordance with the agreement. Only

       one copy of the software is being supplied for each

       site. The licensee is permitted to make only one copy

       of the software and associated support information

       and that also for backup purposes. It is also stipulated

       that     the   copy    so    made   shall    include   Infrasofts

       copyright and other proprietary notices. All copies of

       the Software are the exclusive property of Infrasoft.

       The Software includes a licence authorisation device,

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ITA 1034/2009                                                 Page 163 of 174
       which restricts the use of the Software. The software is

       to be used only for Licensees own business as

       defined within the Infrasoft Licence Schedule. Without

       the consent of the Assessee the software cannot be

       loaned, rented, sold, sublicensed or transferred to any

       third party or used by any parent, subsidiary or

       affiliated entity of Licensee or used for the operation of

       a service bureau or for data processing. The Licensee

       is further restricted from making copies, decompile,

       disassemble or reverse-engineer the Software without

       Infrasofts written consent. The Software contains a

       mechanism which Infrasoft may activate to deny the

       Licensee use of the Software in the event that the

       Licensee is in breach of payment terms or any other

       provisions   of   this   Agreement.    All   copyrights    and

       intellectual property rights in and to the Software, and

       copies made by Licensee, are owned by or duly

       licensed to Infrasoft.




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ITA 1034/2009                                            Page 164 of 174
87.    In order to qualify as royalty payment, it is necessary

       to establish that there is transfer of all or any rights

       (including the granting of any licence) in respect of

       copyright of a literary, artistic or scientific work. In

       order to treat the consideration paid by the Licensee

       as royalty, it is to be established that the licensee, by

       making such payment, obtains all or any of the

       copyright rights of such literary work. Distinction has to

       be made between the acquisition of a "copyright right"

       and a "copyrighted article". Copyright is distinct from

       the      material    object,   copyrighted.   Copyright      is   an

       intangible incorporeal right in the nature of a privilege,

       quite independent of any material substance, such as

       a manuscript. Just because one has the copyrighted

       article, it does not follow that one has also the

       copyright in it. It does not amount to transfer of all or

       any right including licence in respect of copyright.

       Copyright       or    even     right   to   use   copyright        is

       distinguishable        from    sale    consideration    paid      for


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ITA 1034/2009                                                 Page 165 of 174
       "copyrighted" article. This sale consideration is for

       purchase of goods and is not royalty.


88.    The license granted by the Assessee is limited to

       those necessary to enable the licensee to operate the

       program. The rights transferred are specific to the

       nature of computer programs. Copying the program

       onto the computer's hard drive or random access

       memory or making an archival copy is an essential

       step in utilizing the program. Therefore, rights in

       relation to these acts of copying, where they do no

       more than       enable the      effective   operation   of the

       program    by     the   user,   should   be   disregarded      in

       analyzing the character of the transaction for tax

       purposes. Payments in these types of transactions

       would be dealt with as business income in accordance

       with Article 7.


89.    There is a clear distinction between royalty paid on transfer

       of copyright rights and consideration for          transfer of


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ITA 1034/2009                                             Page 166 of 174
       copyrighted articles. Right to use a copyrighted article or

       product with the owner retaining his copyright, is not the

       same thing as transferring or assigning rights in relation to

       the copyright. The enjoyment of some or all the rights

       which the copyright owner has, is necessary to invoke the

       royalty definition. Viewed from this angle, a non-exclusive

       and      non-transferable   licence   enabling   the   use    of    a

       copyrighted product cannot be construed as an authority to

       enjoy any or all of the enumerated rights ingrained in Article

       12 of DTAA. Where the purpose of the licence or the

       transaction is only to restrict use of the copyrighted product

       for internal business purpose, it would not be legally correct

       to state that the copyright itself or right to use copyright has

       been transferred to any extent. The parting of intellectual

       property rights inherent in and attached to the software

       product in favour of the licensee/customer is what is

       contemplated by the Treaty. Merely authorizing or enabling

       a customer to have the benefit of data or instructions

       contained therein without any further right to deal with them

       independently does not, amount to transfer of rights in

       relation to copyright or conferment of the right of using the

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ITA 1034/2009                                                 Page 167 of 174
       copyright. The transfer of rights in or over copyright or the

       conferment of the right of use of copyright implies that the

       transferee/licensee should acquire rights either in entirety

       or partially co-extensive with the owner/ transferor who

       divests himself of the rights he possesses pro tanto.


90.    The license granted to the licensee permitting him to

       download the computer programme and storing it in the

       computer for his own use is only incidental to the facility

       extended to the licensee to make use of the copyrighted

       product for his internal business purpose. The said process

       is necessary to make the programme functional and to

       have access to it and is qualitatively different from the right

       contemplated by the said paragraph because it is only

       integral to the use of copyrighted product. Apart from such

       incidental facility, the licensee has no right to deal with the

       product just as the owner would be in a position to do.


91.    There is no transfer of any right in respect of copyright

       by the Assessee and it is a case of mere transfer of a

       copyrighted article. The payment is for a copyrighted



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ITA 1034/2009                                             Page 168 of 174
       article and represents the purchase price of an article

       and cannot be considered as royalty either under the

       Income Tax Act or under the DTAA.


92.    The licensees are not allowed to exploit the computer

       software commercially, they have               acquired     under

       licence agreement, only the copy righted software

       which by itself is an article and they have not acquired

       any copyright in the software.           In the case of the

       Assessee      company,     the     licensee    to    whom       the

       Assessee company has sold/licensed the software

       were allowed to make only one copy of the software

       and      associated    support     information      for   backup

       purposes with a condition that such copyright shall

       include    Infrasoft   copyright   and   all   copies     of    the

       software shall be exclusive properties of Infrasoft.

       Licensee was allowed to use the software only for its

       own business as specifically identified and was not

       permitted to loan/rent/sale/sub-licence or transfer the



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ITA 1034/2009                                                Page 169 of 174
       copy of software to any third party without the consent

       of Infrasoft.


93.    The licensee has been prohibited from copying, de-

       compiling, de-assembling, or reverse engineering the

       software without the written consent of Infrasoft. The

       licence agreement between the Assessee company

       and its customers stipulates that all copyrights and

       intellectual property rights in the software and copies

       made by the licensee were owned by Infrasoft and

       only Infrasoft has the power to grant licence rights for

       use of the software. The licence agreement stipulates

       that upon termination of the agreement for any reason,

       the      licencee   shall   return    the   software    including

       supporting      information     and     licence   authorization

       device to Infrasoft.


94.    The incorporeal right to the software i.e. copyright

       remains with the owner and the same                     was not

       transferred by the Assessee. The right to use a


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ITA 1034/2009                                                 Page 170 of 174
       copyright in a programme is totally different from the

       right to use a programme embedded in a cassette or a

       CD which may be a software and the payment made

       for the same cannot be said to be received as

       consideration for the use of or right to use of any

       copyright to bring it within the definition of royalty as

       given in the DTAA. What the licensee has acquired is

       only a copy of the copyright article whereas the

       copyright remains with the owner and the Licensees

       have acquired a computer programme for being used

       in their business and no right is granted to them to

       utilize the copyright of a computer programme and

       thus the payment for the same is not in the nature of

       royalty.


95.    We have not examined the effect of the subsequent

       amendment to section 9 (1)(vi) of the Act and also

       whether the amount received for use of software

       would be royalty in terms thereof for the reason that



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ITA 1034/2009                                            Page 171 of 174
       the Assessee is covered by the DTAA, the provisions

       of which are more beneficial.


96.    The amount received by the Assessee under the

       licence agreement for allowing the use of the software

       is not royalty under the DTAA.


97.    What is transferred is neither the copyright in the

       software nor the use of the copyright in the software,

       but      what   is   transferred   is   the   right   to     use     the

       copyrighted material or article which is clearly distinct

       from the rights in a copyright. The right that is

       transferred is not a right to use the copyright but is

       only limited to the right to use the copyrighted material

       and the same does not give rise to any royalty income

       and would be business income.


98.    We are not in agreement with the decision of the

       Andhra Pradesh High Court in the case of SAMSUNG

       ELECTRONICS C O. LTD (SUPRA) that right to make a

       copy of the software and storing the same in the hard

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ITA 1034/2009                                                     Page 172 of 174
       disk of the designated computer and taking backup

       copy would amount to copyright work under section

       14(1) of the Copyright Act and the payment made for

       the grant of the licence for the said purpose would

       constitute royalty. The license granted to the licensee

       permitting him to download the computer programme

       and storing it in the computer for his own use was only

       incidental to the facility extended to the licensee to

       make use of the copyrighted product for his internal

       business purpose. The said process was necessary to

       make the programme functional and to have access to

       it   and   is   qualitatively   different   from   the     right

       contemplated by the said provision because it is only

       integral to the use of copyrighted product. The right to

       make a backup copy purely as a temporary protection

       against loss, destruction or damage has been held by

       the Delhi High Court in DIT v. M/s Nokia Networks OY

       (Supra) as not amounting to acquiring a copyright in

       the software.


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ITA 1034/2009                                             Page 173 of 174
99.    In view of the above we accordingly hold that what has

       been transferred is not copyright or the right to use

       copyright but a limited right to use the copyrighted

       material and does not give rise to any royalty income.


100. The question of law is thus answered in favour of the

       Assessee and against the Revenue that the Income

       Tax Appellate Tribunal was right in holding that the

       consideration received by the respondent Assessee on

       grant of licences for use of software is not royalty

       within the meaning of Article 12(3) of the Double

       Taxation Avoidance Agreement between India and the

       United States of America.


101. The        appeal   is   accordingly   dismissed   leaving     the

       parties to bear their own costs.



                                        SANJEEV SACHDEVA, J.



22nd NOVEMBER, 2013                          SANJIV KHANNA, J.
st

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ITA 1034/2009                                             Page 174 of 174

 
 
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