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2017 Supreme(Del) 213
IN THE HIGH COURT OF DELHI AT NEW DELHI
S. RAVINDRA BHAT, NAJMI WAZIRI, JJ.
The Commissioner of Income Tax, International Taxation-2 - Appellant
Versus
ZTE Corporation - Respondent
ITA 904, 905, 906, 907, 908 & 909 of 2016, CM APPL. 46510, 46511, 46512, 46513 & 46515 of 2016
Decided On : 24-01-2017
Mr. Ruchir Bhatia, Mr. Puneet Rai, on behalf of Revenue, in all the appeals
Mr. Deepak Chopra, Mr. Harpreet Singh Ajmani, Mr. Rohan Khare, Advocates for the assessees in all the appeals.
The main legal point established in the judgment is that payments made for the right to use software, which is an integral part of equipment, are in the nature of business profits and not royalty.
Headnote:
Interpretation of Article 12(3) of Indo-China DTAA - Section 234B of Income Tax Act, 1961 - [Article 12(3), Section 234B]
Fact of the Case:
The assessee, a tax resident of China, supplied telecom equipment to Indian operators and mobile handsets to customers in India. The Assessing Officer (AO) concluded that the assessee had a business connection in India and its business had been carried through its Permanent Establishment (PE) in India. The CIT(A) held that 2.5% of total sales made by the foreign company in India was to be attributed as business profits of PE. The ITAT attributed 35% of net global profits to PE in India for both hardware and software supplied to Indian customers. The ITAT also held in favor of the assessee on the applicability of Section 234-B and the nature of payments for embedded software.
Finding of the Court:
The court held that the payments made for the right to use the software were not royalty and were in the nature of business profits. The court also ruled in favor of the assessee on the issue of interest under Section 234B.
Issues: Interpretation of Article 12(3) of Indo-China DTAA, applicability of Section 234B
Ratio Decidendi: The court found that the software supplied was an integral part of the telecom equipment and was necessary for its functioning, and therefore, the payments for the right to use the software were in the nature of business profits and not royalty. The court also relied on previous judgments and the provisions of the Copyright Act to support its decision.
Final Decision: The court dismissed the revenue's appeals and ruled in favor of the assessee on both issues.
S. Ravindra Bhat, J.
1. In these appeals, the following questions of law arise for consideration:-
(i) Are the ITAT’s findings with respect to interpretation of Article 12(3) of the Indo-China Double Taxation Avoidance Agreement (DTAA), in the light of Explanations 5 & 6 to Section 9(1)(vi), erroneous in law.
(ii) Is the impugned order correct in its interpretation of Section 234B of the Income Tax Act, 1961, in the facts and circumstances of the case.
2. Brief facts of the case are that the assessee is a tax resident of the Republic of China and is engaged in the business of supplying telecom equipment. During the financial years, relevant to the subject assessment year, it was engaged in supply of telecom equipment to Indian telecom operators; it also supplied mobile hand-sets to customers in India. It did not file its return of income arguing that it had no Permanent Establishment (PE) in India in terms of the provisions of Article 5 of the Indo-China Double Taxation Avoidance Agreement (“DTAA”). On 6.10.2009 a survey under Section 133A was undertaken at its premises and several documents were seized. Statements of its senior executives were also recorded. On the basis of these documents and statements, the Assessing Officer (AO) formed the opinion that the assessee had a business connection in India and its business had been carried through its PE in India and further income had accrued to it during the relevant year from such business.
3. A notice under Section 148 of the Income Tax Act (“the Act”) was issued on 23.10.2009 requiring the assessee to file its return of income; it did so, declaring Nil income. In the notes to the "statement showing computation of income" the assessee stated that since it did not have PE in India, its revenues were not taxable as business profits. It made detailed submissions justifying that it had no fixed place PE, no dependent agency PE in India, no installation PE and no service PE. It also urged that no part of profits of supplies could be attributed to the independent PE unless it was established by the revenue that the supplies were not at arm's length price.
4. The AO after examining various statements, concluded that the assessee had fixed place PE, installation PE, dependent agency PE in India and, therefore, the revenues from the supply of telecom equipment and mobile hand sets were to be taxed in India as business profits. He, therefore, proceeded to determine the profits attributable to the assessee's PE in India. Before computing the profits he pointed out that the profits to the PE in India have to be computed separately in respect of hardware and software components of the telecom equipment and the mobile handsets.
5. The assessee had contended before the AO that the software embedded in the telecom equipment or provided to the customers separately, or software supplied to the various customers in India should not be treated as royalty under Section 9(1)(vi) of the Act and also under Article 12(3) of the DTAA. The assessee had argued that:-
a. Software is sold in the same manner as telecom equipment,
b. The software is an integral part of the telecom equipment, which facilitates running of the said equipment.
c. The subject software has no independent value of its own.
d. No copyrights in the software are transferred to the customers.
e. No access to the "source codes" in the software is granted to the customer.
f. Payment for software is not related to the productivity, use or number of subscribers.
g. Customers do not have the right to commercially exploit the software.
h. Software supply is in the nature of transfer of copyrighted article and not transfer of "a copyrighted right".
6. The assessee also relied on the definition of "copyright" under Section 14 of the Indian Copyright Act, 1957. It also relied on the decision of Delhi Special Bench Tribunal in Motorola India vs. DCIT (95 ITD 269). It was therefore stated that the receipts from sale of computer software is in the n
