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Treaty between India and UK – Indian decision on whether payments for software constitutes royalty or business income

The Indian Income Tax Appellate Tribunal (ITAT) delivered a ruling dated 19 December 2008 in the case of Infrasoft Ltd. v. ADIT (International Tax) (ITA No. 847/Del/2008) on whether payments for customized software should be taxed as "royalty" or "business profits".

(a) Facts. The Taxpayer (i.e. Infrasoft Ltd.) was a marketing and development company incorporated in the United Kingdom with a branch/permanent establishment (henceforth, "the Branch") in India. The Branch imported software for its Indian customers. The software was customized for the Indian customers under a license agreement, which imposed limitations on the customers' right to copy, sell, use, etc., the software.

The Tax Authorities held that the Indian customers were able to exploit the intellectual property contained in the software and therefore, the income was in the nature of "royalty" and taxable in India under Art. 13 of the India-UK tax treaty and under the Indian Income Tax Act 1961. Furthermore, the Tax Authorities stated that the OECD's stand on the matter was not binding in India and that each country could formulate its own principles on the matter. They further argued that India was not a member of the OECD and had expressed its reservations.

The Taxpayer contended that the Indian customers were not entitled to exploit the intellectual property contained in the software and that there was existing case law to support their position that the payment was in the nature of "business income" taxable under Art. 7 of the Tax Treaty and not "royalty". (Note: In India, royalty would be taxed at a rate of 20% of the gross payment while business income would be taxed at a rate of 42% of the net amount).

The Commissioner of Income Tax (Appeals) accepted the Tax Authorities' stand, and the Taxpayer appealed to the ITAT.

(b) Issue. The issue before the ITAT was whether the payment for the use of the customized software was in the nature of "business income" from an outright sale or a "royalty".

(c) Decision. The ITAT held that the payments were in the nature of "business income" and not "royalty" as the Indian customers did not receive any right in the intellectual property contained in the software.

The ITAT reiterated the facts in the cases of:

-   Samsung Electronics Co. Ltd. where the ITAT held that the acquisition of off-the-shelf computer software did not result in the right to utilize the copyright in the programme and therefore the payment did not constitute "royalty"; and
-   Motorola Inc. where the ITAT differentiated between the sale of a copyrighted article from the transfer of a copyright,

were similar to the current case and should be followed.

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