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[ITAT] Revenue from Software Licensing Fees and Annual Maintenance Contracts Not Taxable in India Due to Absence of Permanent Establishment

Introduction

Openwave Mobility Inc. (‘Assessee’), a tax resident of the USA, earned revenue by providing software and an annual maintenance contract (‘AMC’) of such software to Indian customers. The Assessee, claiming no permanent establishment (‘PE’) in India, filed its income tax return (‘ITR’) under the India-USA Double Taxation Avoidance Agreement (‘DTAA’), declaring its receipts as non-taxable and seeking a refund for tax deducted at source. The assessing officer (‘AO’) held the said receipts as taxable and accordingly made additions. The dispute resolution panel later separated the transactions, ruling the software licensing fee as business income (non-taxable) and the AMC services as fees for technical services (‘FTS’) (taxable). The Assessee appealed, and the Income Tax Appellate Tribunal (‘ITAT’) in the case of Openwave Mobility Inc. v. Deputy Commissioner of Income-tax[i] ultimately decided in favour of the Assessee, determining that neither the software licensing fees nor the AMC services were taxable in India due to the absence of a PE.

Brief Facts

  • The Assessee was a tax resident of the USA, providing software services to telecom operators globally, without any business connection or PE in India.

  • The Assessee entered into a software licensing agreement (‘SLA’) with Reliance Jio Infocomm Ltd. (‘RJIL’) for the supply of software. Additionally, a service level agreement was executed for providing AMC, resulting in income from software licensing and AMC services during the assessment year (‘AY’) 2019-20.

  • The Assessee filed its ITR, declaring these receipts as non-taxable in India under the DTAA and sought a refund for tax deducted at source (‘TDS’) by RJIL. The case was selected for scrutiny under CASS due to a high ratio of refund to TDS.

  • Statutory notices were issued, to which the Assessee duly responded. The Assessee argued that the receipts did not qualify as FTS under a. 12 of the DTAA and should be considered business income, not taxable in India due to the absence of a PE.

  • The AO treated the receipts as taxable and made additions to the income of the Assessee. This decision was based on the SLA, which described the software as a proprietary, non-exclusive, non-transferable, and perpetual solution, including future updates and integration at no extra cost.

  • The AO determined that the software was not a mere product sale but a proprietary process imparting significant usage rights, creating a hybrid model exclusive to the Assessee. Additionally, the AO noted that support and maintenance services were intertwined with the software license, provided in close collaboration with the employees of the Assessee, and included training, thus meeting the FTS criteria under the DTAA.

Objection before the Dispute Resolution Panel (‘DRP’)

  • Aggrieved by the decision of the AO, the Assessee filed an objection before the DRP.

  • The DRP highlighted two distinct transactions in the agreement, namely, the supply and license of certain software and the provision of AMC services. The DRP observed that these transactions were not inextricably related and were considered separately.

  • The DRP relied on the decision of the Hon’ble Supreme Court (‘SC’) in the case of Centre of Excellence Pvt. Ltd. v. CIT[ii] and held that the software licensing fee is not royalty income but business income under a. 7 of the DTAA, which is not taxable in India due to the absence of a PE.

  • However, the DRP held that the AMC services constituted FTS or fee for included services (‘FIS’) under a. 12(4)(b) of the DTAA, as they involved technical knowledge and skills made available to RJIL.

  • The AO completed the assessment, treating the entire receipts as FTS/FIS and making additions accordingly.

  • Aggrieved, the Assessee filed an appeal before the ITAT.

Arguments by the Assessee before the ITAT

  • The Assessee argued that the assessment order by the AO was a nullity in the eyes of the law as it violated the direction of the DRP regarding the non-taxability of software licensing fees. This argument was supported by citing the decision of the previous case in Openwave Mobility Inc. v. DCIT[iii].

  • It was argued that the AMC services provided by the Assessee were ancillary to software licensing and should be characterized similarly. This argument was supported by judicial precedents such as Aspect Software Inc. v. ADIT[iv].

  • Additionally, it was argued that the AMC services did not qualify as FTS/FIS under the DTAA, as they did not meet the ‘make available’ test. This argument was supported by citing the decision of the SC in CIT v. Bharti Cellular Ltd.[v]

  • The Assessee argued that no technical knowledge was provided to the employees of RJIL, thus failing to meet the criteria for FTS/FIS under the DTAA.

Held

  • The ITAT observed that the software supplied by the Assessee was a copyrighted article, not a copyright in the software, and therefore the consideration received for licensing was not taxable as royalty income under a. 12 of the DTAA.

  • Regarding the AMC services, the ITAT noted that they were ancillary to the software license and should be characterized similarly. The ITAT also found that the ‘make available’ test under a. 12(4)(b) of the DTAA was not satisfactory, as the services provided did not enable the recipient to use technical knowledge independently.

  • The ITAT had concluded that the entire receipts from software licensing and maintenance/support services were non-taxable in India, as they constituted business profits of the Assessee not taxable in the absence of a PE in India, in accordance with a. 7 of the DTAA. Therefore, the appeal of the Assessee had been allowed.

Conclusion

The ITAT in this case held that the software licensing fees and AMC services provided by the Assessee were non-taxable in India due to the absence of a PE. The ITAT observed that the software supplied was a copyrighted article, not royalty income under a. 12 of the DTAA, thus constituting non-taxable business income. For the AMC services, the ITAT determined these were ancillary to the software license and did not meet the ‘make available’ test under a. 12(4)(b) of the DTAA, which requires that technical knowledge or skills be provided in a manner enabling the recipient to use them independently in the future.





End Notes

[i] [2024] 162 taxmann.com 434 (Delhi - Trib.) dated 01.05.2024.

[ii] (2002) 3 SCC 321

[iii] W.P.(C) 13659/2022

[iv] [2015] 61 taxmann.com 36/172

[v] [2010] 193 Taxman 97 (SC)

 






Authored by Nitish Solanki, Advocate at Metalegal Advocates. The views expressed are personal and do not constitute legal opinion.

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