Case of Authority for Advance Rulings, January 29, 2010 (case Dassault Systems K.K. Vs Director of Income-tax, (International Taxation)-I)

PresidentMr. Justice P.V. Reddi (Chairman) & MR. J. Khosla (Member)
Resolution DateJanuary 29, 2010


Mr. Justice P.V. Reddi (Chairman) & MR. J. Khosla (Member)

  1. The applicant is a company incorporated under the laws of Japan engaged in the business of providing ''Products Lifecycle Management'' software solutions, applications and services. The applicant markets the licensed software products mostly through a distribution channel comprising Value Added Resellers (VAR). It is stated that VARs are independent third party resellers who are in the business of selling software to end-users. To authorize a VAR to act as the reseller of Products, the applicant enters into a General VAR Agreement ("GVA"). The applicant states that as per the business model, the Product is sold to VAR for a consideration based on the standard list price less discount. The VAR in turn will sell such product to the end-users at a price independently determined by VAR. The end-user will enter into End User License Agreement ("EULA") with the applicant and VAR for the product supplied. The reseller (VAR) gets the order from end-user and places a back-to-back order on the applicant. On acceptance of the order by the applicant, it will provide a license key via e-mail so that the customer will directly download the product through the web link.

  2. The modus operandi of the transactions has been set out in brief as follows: -

    The process starts with the VAR discussing with the end customer details regarding the technical solution i.e. the software and the budget of such end-customer; -

    The VAR makes a proposal to end-customer. This proposal includes a copy of the standard tripartite End User License Agreement (EULA).

    In a few cases the VAR forwards a Special Bid Offer (SBO) to applicant, typically to decrease their purchasing price. Applicant does not know the price that VAR intends to propose to the end customer in all cases. If applicant agrees, they then propose to VAR a maximum discount. VAR does not share this information with endcustomer. -

    VAR obtains a Purchase Order (PO) from the end customer. Applicant does not know of this PO, as this is an arrangement between VAR and end customer. The credit control and risk in relation to the end customer lies solely with the VAR. -

    Simultaneously, VAR also obtains a signed and sealed End User Order Form from the customer, which describes the software ordered and whereby end customer accepts the licensing terms of the EULA. This EUOF does not bear the end customer price. The EULA is standard and does not bear any price. -

    The VAR then places a PO with the applicant with the price obtained from either the SBO request or based on list price minus VAR discount. The End customer has no knowledge of this PO, since this is an arrangement between the applicant and VAR. For an order of a new software product, the Brand Order Form must be accompanied with a request for media, a request for license key and the signed EUOF; - The applicant is not duty bound to accept the PO; -

    If and when the PO is accepted, the applicant provides a license key via e-mail and download link directly to end customer. Simultaneously it invoices the VAR.

    2.1. As to the manner of supply of product to the customer, the applicant states: The product will be hosted on a server located outside India. The end-user in India will electronically download the Product by accessing the web link directly on its computer system/storage media. In case the end user is not equipped with the required network infrastructure (bandwidth) to download the product, such download will be made by the end user at VAR''s location. In such a situation the end user will carry its own portable storage device to VAR''s location for downloading the Product. No copy of the Product will be saved, even on a temporary basis, on the computer system/ infrastructure of the VAR. VAR is prohibited from opening or using the product. After the download of the product, the end user will use the license key to activate the software and register the license. Such license key would be generated by the applicant to function only on customer''s designated machine identified by internal code attached to their processor.

    2.2. The applicant submits that the said transaction between

    (a) the applicant and VAR,

    (b) VAR and the End-user is on principal to principal basis and that it has no presence in India whether through any employees or in the form of an office or place of business.

  3. The following question is framed by the applicant in order to seek advance ruling from this Authority: Whether on the facts and circumstances of the case and in law the payment received by Dassault Systems K.K. (hereinafter referred to as the "the applicant") from sale of software products to independent third party resellers will be taxable as business profits under Article 7 of the India-Japan Double Taxation Avoidance Agreement ("India-Japan DTAA" or "Treaty") and will not constitute ''royalties and fee for technical services'' as defined in Article 12 of India-Japan DTAA?

  4. Broadly, the applicant''s contention is that the payment made by VAR to the applicant is not in the nature of royalty within the meaning of Article 12.3 of the DTAA1 (or ''Treaty'') between India and Japan notified by the Central Govt. under Section 90 of the Income Tax Act on 1.3.1990 and secondly it cannot be subjected to Indian income tax in view of Art.7.1 of the DTAA by reason of absence of Permanent Establishment in India.

  5. It is trite that the assessee can invoke the provisions of the Income Tax Act or the India-Japan DTAA, whichever is beneficial to it (vide Section 90(2) of the Income Tax Act, 1961). In other words, the provisions of DTAA will prevail over the provisions of the I.T.Act on the same subject-matter in a case of conflict if they are more beneficial to the tax-payer (vide Union of India vs. Azadi Bachao Andolan2. The Circular of CBDT dt.12th April 1982 approvingly cited by Calcutta High Court in Davy Ashmore''s case (190 ITR 626) further clarifies that "where a specific provision is made in the 1 Agreement for Avoidance of Double Taxation and Prevention of Fiscal Evasion 2 263 ITR 706 at pages 723 & 724 DTAA, that provision will prevail over the general provisions contained in the IT Act". At this juncture, we may mention that there is no material difference and no conflict between the provisions of the Act and DTAA and therefore the conclusion is reached by referring to both.

  6. Article 12 of the DTAA lays down the rules for taxation of "royalties". The relevant part of Art. 12 is extracted below:

    "Article 12. 1. Royalties and fees for technical services arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other Contracting State.

  7. However, such royalties and fees for technical services may also be taxed in the Contracting State in which they arise and according to the laws of that Contracting State, but if the recipient is the beneficial owner of the royalties or fees for technical services, the tax so charged shall not exceed 10 per cent of the gross amount of the royalties or fees for technical services.

  8. The term ''royalties'' as used in this article means payments of any kind received as a consideration for the use of, or the right to use, any copyright of literary, artistic or scientific work including cinematograph films and films or tapes for radio or television broadcasting, any patent, trade mark, design or model, plan, secret formula or process, or for the use of, or the right to use, industrial, commercial or scientific equipment, or for information concerning industrial, commercial or scientific experience." Art.12.1 of DTAA enjoins that royalties and fees for technical services arising in a contracting state and paid to a resident of the other contracting state may be taxed in that other contracting state. However, this general rule is qualified by para 2 which enables the contracting State in which they arise to tax the same according to the laws of that State subject to the limitation that the beneficial owner of royalties or f.t.s shall not be subjected to tax at a rate more than 10% of the gross amount.

  9. Under the Income-Tax Act, the income arising from royalty is deemed to accrue or arise in India and the non-resident is liable to be taxed under Section 9(1)(vi) of the Act. Explanation 2 thereto defines ''royalty'' The relevant part of the definition contained in clause (v) is:"royalty" means consideration for the transfer of all or any rights (including the grant of a licence) in respect of any copyright, literary, artistic or scientific work, patent, invention, model, design, secret formula or process, trade mark or similar property.

  10. The first and foremost question is whether the payments received by the applicant from the VARs represent consideration for the use of, or the right to use, any copyright of literary/scientific work. Going by the language of the Act, the question is whether there is transfer of all or any rights in respect of the copyright of literary or scientific work.

  11. Before entering into a discussion on the applicability of the royalty definition, it is appropriate to recapitulate certain basic principles concerning the copyright as a legal concept. We may, in this connection, refer to some passages from the classic treatise of Copinger and Skone James on Copyright (1999 Edn):

    "Copyright gives the owner of the copyright in a work of any description the exclusive right to authorize or prohibit the exploitation of the copyright work by third parties. This includes the right to copy the work itself and also to use the work in other ways protected under the law".(p.26)

    Copyright is often described as a negative right. This idea is conveyed by Copinger in the following words: "Copyright, however, does not essentially mean a right to do something, but rather a right to restrict others from doing certain acts, and, when copyright is referred to as "an exclusive right," the emphasis...

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