Revisiting Tax of Royalty on Computer Software

Abstract

When a special bench of Income Tax Appellate Tribunal (ITAT) held in 2005 that income earned by Motorola Inc. from supply of computer software to Indian Residents was not in the nature of ‘royalty’, a contentious issued was settled for good. This legal position was followed consistently until recently when two division bench decision of the ITAT in Gracemac Corporation and TII Team Telecom have taken divergent views to seemingly unsettle the position in Motorola Inc., thus requiring a revisit to similar business models.

In Motorola Inc., after considering the relevant provisions, applicable decisions and the India-United States Double Taxation Avoidance Agreement (DTAA), the Special Bench had concluded 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”.

In Gracemac Corporation the Delhi Bench of the ITAT has held that since the relevant statutory provision was not ambiguous and did not refer to an expression ‘copyrighted article’, it was not open to read the expression so as to be of any relevance in deciding whether a payment was for royalty or otherwise. It was also concluded that the assessee could not press into service the observations in the OECD Commentary or the US IRS Regulations (which refer to ‘copyrighted article’) in view of a categorical enunciation of the Supreme Court on this issue.

It was also held that payments made in the nature of ‘royalty’ as they could be covered as consideration for the use or right to use computer software and thus in the nature of (a) patent; (b) process; and (c) inventions. In any case, it was also held, the rights granted to the user were in the nature of a license in copyright and other intellectual property rights only and thus the income from grant of such right was in the nature of ‘royalty’ only. The fact that Parliament had prescribed a special rate of income tax in respect of royalty income in respect of any computer software under Section 115A(1A) was also considered.

For these reasons the division bench of ITAT distinguished the decision in Motorola Inc. It may be noted that even though the division bench was deciding in the context of India-United States DTAA, yet it distinguished the Motorola Inc. decision. The division bench also did not state that Motorola Inc. was incorrect or required reconsideration in view of the different provisions not considered by the special bench.

After the Gracemac Corporation decision the Mumbai Bench of the ITAT in TII Team Telecom considered the taxation of payment made by the assessee to an Israel company towards supply of software for telecom instruments wherein relief had been given to the assessee by the CIT(A). Noting that the Gracemac Corporation had taken a contrary view, in TII Team Telecom the Mumbai Bench held that the issue “as to whether payment for supply of software can be viewed as a payment for copyright or not is no longer res integra. The Special Bench has decided this issue in favour of the assessee, and the views so expressed by the Special Bench, being from a higher forum than this division bench, are binding on us”. It was also therein noted that “Copyright is one thing, and copyrighted article is quite another thing. To give a simple example, when a person is using a music compact disc, that person is using the copyrighted article, i.e. the product itself, and not the copyright in that product.” On this note the decision of TII Team Telecom follows and Motorola Inc. holding that the decision in Gracemac Corporation being “contrary to earlier precedents on that issue from other coordinate benches, does not bind the subsequent coordinate benches”.

It is interesting to note that both the Delhi Bench in Gracemac Corporation and the Mumbai Bench in TII Team Telecom relied upon similar decisions but concluded otherwise. In any case, the question that now arises as to what is the correct legal position to take. Two legal propositions merit consideration. First that when a subsequent bench of Supreme Court interprets an earlier Bench of the Court, the law as interpreted in the subsequent bench would apply as the law of the land. Similarly analogy would seem to apply for the decision of ITAT. Second, the Supreme Court has continuously held that it is mandatory for a co-ordinate bench of a Tribunal to follow the decision of a larger bench, the only recourse in the event of disagreement being to refer the matter for reconsideration by a larger bench. On this count the decision in TII Team Telecom seems to reflect the correct position of law.

Strictly interpreting, therefore, in the light of the settled legal propositions, one would not be at fault to follow the decision in TII Team Telecom. However the conflicting decisions would come to haunt the business in as much as the categorical enunciation in Motorola Inc. has been deviated from and thus broken the consistency which had been in vogue for fairly long to be accepted by the Department. Nonetheless one may note with caution that the additional reasons assigned in Gracemac Corporation to not follow Motorola Inc. may well be considered by an appropriate forum in a similar matter.

On a temperate vein it may also be noted that the Federal Court of Australia recently in IBM’s case has held that software license fee is ‘royalty’ within the meaning of Australia-United States DTAA.

Keywords: Income Tax, Royalty, Copyright, Copyrighted Article, India

JEL Classification: H21, H25, H29, K34