ADIT vs. TII Team Telecom International Pvt Ltd (ITAT Mumbai)

Income from license of software not assessable as “royalty”. Gracemac not followed; Motorola still good law

The assessee, an Israeli company, entered into an agreement with Reliance Infocomm for supply and licence of software for RIL’s wireless network in India. The assessee received Rs. 3 crores which it claimed to be “business profits” and not taxable for want of a permanent establishment (PE) in India. The AO took the view that the said sum was assessable as “royalty”. This was reversed by the CIT (A) following Motorola Inc 96 TTJ 1 (Del) (SB). In appeal before the Tribunal, the department argued that in view of Gracemac Corp 42 SOT 550 (Del), the use of software was assessable as “royalty”. HELD dismissing the appeal:

(i) Under Article 12 (3) of the India-Israel DTAA, royalty is defined inter alia to mean payments for the “use of” a “copyright” or a “process”. There is a distinction between “use of copyright” and “use of a copyrighted article”. In order to constitute “use of a copyright”, the transferee must enjoy four rights viz: (i) the right to make copies of the software for distribution to the public, (ii) The right to prepare derivative computer programmes based upon the copyrighted programme, (iii) the right to make a public performance of the computer programme and (iv) The right to publicly display the computer programme. If these rights are not enjoyed, there is no “use of a copyright”. The consideration is also not for “use of a process” because what the customer is paying for is not for the “process” but for the “results” achieved by use of the software. It will be a “hyper technical approach totally divorced from ground business realities” to hold that the use of software is use of a “process”. (Motorola Inc 96 TTJ 1 (Del) (SB) and Asia Sat 332 ITR 340 (Del) followed. Gracemac Corp 42 SOT 550 (Del) not followed);

(ii) It is well settled that a DTAA prevails over the Act where it is more favourable to the assessee. The view taken in Gracemac, relying on Gramophone Co AIR 1984 SC 667, that the Act overrides the treaty provisions where there is irreconcilable conflict is not acceptable because (a) it is obiter dicta, (b) contrary to Azadi Bachao Andolan 263 ITR 706 (SC) and (c) Gramophone Co not applicable to I. T. Act as it dealt with law in which specific enabling clause for treaty override did not exist. (Ram Jethmalani vs UOI also considered).