The verdict in B4U International has sent shock waves across the Country because it implies that the retrospective amendments in the Finance Act 2012 to the definition of the term “royalty” so as to rope in software income and equipment hire charges are infructuous in the absence of a corresponding amendment to the definition of that term in the DTAA. The author puts the issue in perspective and explores the way forward for the Government
The verdict of the ITAT Mumbai in B4U International must have come as a nasty shock to the mandarins of North Block because while these worthies thought that by amending s. 9(1)(vi) of the Income-tax Act with retrospective effect, they had accomplished the mission of taxing software receipts, they overlooked one minor detail – the Double Taxation Avoidance Agreement!
One can well imagine the scenario in the court room when the B4U International appeal was being argued. The department’s counsel must have sauntered into the court room with an exaggerated swagger and a smug grin on his face, put his elbows on the podium, rolled his eyes and drawled “MiLord, please see the retrospective amendments. All the judgements cited by my learned friend are now totally worthless”
Lets’ get some background first. The question whether software receipts are assessable as “royalty” arose after the verdict of the Supreme Court in Tata Consultancy Services 271 ITR 401 (SC). There, the Supreme Court held, in the context of the Customs Act, that software embedded in a CD was “goods” and liable to customs duty.
The assesses were quick to pounce on this to argue that when software was licensed, there was a transfer of a “copyrighted article” and not the transfer of a “copyright” and so the consideration was not assessable as “royalty” u/s 9(1)(vi) and its corresponding provision in the DTAA.
The argument found favour with the Special Bench in Motorola 95 ITD 269 (SB) and the AAR in Dassault Systems 229 CTR 105 (AAR). However, just when everyone thought that the law was settled, the ITAT Delhi Bench sent out a shocker by deciding against the assesses in Microsoft Corporation 134 TTJ (Del) 257.
That started a free-for-all with everyone being able to take any view that he pleased. The ITAT Mumbai Bench in TII Team Telecom 140 TTJ (Mum) 649 decided not to toe the Microsoft line and held that software receipts were not “royalty”. This was endorsed by the Delhi High Court in Ericsson AB 204 TM 192. On the other hand, the Bangalore Bench of the ITAT decided in ING Vyasa Bank 143 TTJ (Bang) 249 that the contrary view was more appealing. This was endorsed by the AAR in Millenium (AAR) and the Karnataka High Court in Samsung 203 TM 477.
The situation also become a bit chaotic and comic because, faced with two conflicting High Court verdicts, the Tribunal Benches were free to follow whichever view appealed to them. Fortunately for the assessees, in Solid Works Corporation and Allianz SE the Delhi High Court law was followed by the Mumbai and Pune Benches respectively as that was in favour of the assessee.
A similar controversy arose on the question whether hire charges for use of equipment could be assessed as “royalty”. In Asia Satellite 85 ITD 478, the Delhi bench of the ITAT decided in favour of the revenue though a contrary view was taken in PanAmSat 103 TTJ 861. The issue was referred to the Special Bench which, in New Skies Satellite 121 ITD 1 (SB), ruled in favour of the revenue. However, the department’s joy was short-lived because the High Court in Asia Satellite 332 ITR 340 reversed the Special Bench and upheld the assessee’s plea. It was held that to constitute “user”, the payer of the fee had to have “control” over the equipment. If the equipment was used to provide a standard service, then there was no “user” by the payer, it was held.
So, what was the way to resolve the controversy? Simple, if you ask the mandarins of North Block. Simply amend the law with retrospective effect and all your troubles are over.
So it is that the law was amended by the Finance Act 2012 with retrospective effect from 1.6.1976 to provide that software receipts and hire charges would be assessed as royalty. Lets’ take a look at the law pre and post amendment:
Definition of the term “royalty” in Explanation 2 to s. 9(1)(vi) pre-amendment:
Explanation 2.—For the purposes of this clause, “royalty” means consideration (including any lump sum consideration but excluding any consideration which would be the income of the recipient chargeable under the head “Capital gains”) for—
(i) the transfer of all or any rights (including the granting of a licence) in respect of a patent, invention, model, design, secret formula or process or trade mark or similar property ;
(ii) the imparting of any information concerning the working of, or the use of, a patent, invention, model, design, secret formula or process or trade mark or similar property ;
(iii) the use of any patent, invention, model, design, secret formula or process or trade mark or similar property ;
(iv) the imparting of any information concerning technical, industrial, commercial or scientific knowledge, experience or skill ;
(iva) the use or right to use any industrial, commercial or scientific equipment but not including the amounts referred to in section 44BB;
(v) the transfer of all or any rights (including the granting of a licence) in respect of any copyright, literary, artistic or scientific work including films or video tapes for use in connection with television or tapes for use in connection with radio broadcasting, but not including consideration for the sale, distribution or exhibition of cinematographic films ; or
(vi) the rendering of any services in connection with the activities referred to in sub-clauses (i) to (iv), (iva) and (v).
Explanation 3.—For the purposes of this clause, “computer software” means any computer programme recorded on any disc, tape, perforated media or other information storage device and includes any such programme or any customized electronic data;
Explanation 4 to 6 inserted by the Finance Act 2012 in s. 9(1)(vi) with retrospective effect from 1.6.1976:
Explanation 4.—For the removal of doubts, it is hereby clarified that the transfer of all or
any rights in respect of any right, property or information includes and has always
included transfer of all or any right for use or right to use a computer software (including
granting of a licence) irrespective of the medium through which such right is transferred.
Explanation 5.—For the removal of doubts, it is hereby clarified that the royalty includes
and has always included consideration in respect of any right, property or information,
whether or not—
(a) the possession or control of such right, property or information is with the payer;
(b) such right, property or information is used directly by the payer;
(c) the location of such right, property or information is in India.
Explanation 6.—For the removal of doubts, it is hereby clarified that the expression
“process” includes and shall be deemed to have always included transmission by satellite
(including up-linking, amplification, conversion for down-linking of any signal), cable,
optic fibre or by any other similar technology, whether or not such process is secret.
what is the way out for the government? The solution – on which the mandarins are a past master – is to simply amend s. 90(2) to provide that the definition of the term “royalty” in s. 9(1)(vi) will override the definition of that term in all the DTAAs. While this measure will have the local and international community foaming and frothing at the mouth with fury, there is nothing that they can do about it
However, in their unholy excitement to collect the tax, the Mandarins forgot altogether about the DTAA which has a definition of the term” royalty” similar to that in the unamended s. 9(1)(vi).
So, what was held by the Courts in the context of the unamended s. 9(1)(vi) would continue to apply to the DTAA!
One can well imagine the scenario in the court room when the B4U International appeal was being argued. The department’s counsel must have sauntered into the court room with an exaggerated swagger and a smug grin on his face, put his elbows on the podium, rolled his eyes and drawled “MiLord, please see the retrospective amendments. All the judgements cited by my learned friend are now totally worthless”. The assessee’s counsel would have softly interjected “But MiLord, the DTAA has not been amended. Your Lordships are aware that as per Azadi Bachao Andolan 263 ITR 706 (SC) the DTAA prevails over the Act”.
That would have left the department’s counsel dumbfounded and speechless and totally perplexed about how to deal with the situation. How could the mandarins have overlooked this elementary point, he must have cursed.
So it is that in B4U International, the dreaded retrospective amendments were turned to naught.
Now the question is what is the way out for the government? One way is to amend each of the DTAAs to bring it in line with the amendments made to s. 9(1)(vi). However, this is easier said than done because negotiating these agreements at an inter-governmental level can take years. The other solution – on which the mandarins are a past master – is to simply amend s. 90(2) to provide that the definition of the term “royalty” in s. 9(1)(vi) will override the definition of that term in all the DTAAs. While this measure will have the local and international community foaming and frothing at the mouth with fury, there is nothing that they can do about it.
Old timers will recall that a similar controversy had arisen over the question whether the non-discrimination clause in the DTAA would apply to the higher rate of tax payable by foreign companies. This issue was resolved – in favour of the department – by the retrospective insertion of Explanation 1 to s. 90 by the Finance Act 2001 w.r.e.f. 1.4.1962 to “declare for the removal of doubts” that the higher rate of tax would not be discriminatory. That did the job and kept the mandarins happy.
So, the bottom-line of this entire treatise: Brace yourself for yet another retrospective amendment to nullify the B4U International verdict!
Vellalapatti Swaminathan Iyer