The Mumbai Bench of the Income Tax Appellate Tribunal (ITAT) held that consideration received for supply of software cannot be taxed as royalty under the India-Germany Double Taxation Avoidance Agreement (DTAA).
The bench of Beena Pillai (Judicial Member) and Prabhash Shankar (Accountant Member) reaffirmed that royalty and fees for technical services (FTS) are taxable only upon actual receipt and not on accrual basis under the treaty.
The appeals arose from final assessment orders passed under Section 143(3) read with Section 144C(13) of the Income Tax Act pursuant to directions issued by the Dispute Resolution Panel (DRP). The issues involved included: Taxability of royalty and FTS on accrual versus receipt basis; Characterisation of software receipts as royalty; Alleged existence of an Association of Persons (AOP) between Siemens AG and Siemens Limited, India; Taxability of offshore supplies and offshore services; Transfer pricing adjustments and related issues.
The Tribunal noted that all these issues had already been adjudicated in Siemens AG’s own cases for earlier assessment years and therefore followed the earlier precedents.
One of the principal controversies concerned whether royalty and fees for technical services earned by Siemens AG should be taxed when they accrued or only when they were actually received.
The Revenue had argued that income should be taxed on accrual basis. However, Siemens AG relied upon the India-Germany DTAA and earlier judicial precedents holding that such income becomes taxable only upon receipt.
The Tribunal agreed with the taxpayer and followed its earlier decisions as well as judgments of the Bombay High Court rendered in Siemens AG’s own cases. It observed that Article 12 of the India-Germany DTAA repeatedly uses expressions such as “paid,” “payments received,” and “payments of any amount,” indicating that royalty and FTS income become taxable only when payment is actually received.
Accordingly, the Tribunal directed the Assessing Officer to tax royalty and FTS on receipt basis rather than on accrual basis.
Another major issue related to software supplied by Siemens AG along with specialised equipment.
The Revenue sought to classify consideration received for software as royalty. Siemens AG argued that the software was merely standard off-the-shelf software supplied with equipment and that customers only received limited user rights without acquiring any copyright rights.
The Tribunal accepted the taxpayer’s contention and noted several important facts that the software was standard software and not customised intellectual property. Customers received only a non-exclusive and non-transferable licence. End users were prohibited from reverse engineering, modifying, copying for commercial exploitation, or exploiting the software independently. The software functioned only with Siemens-manufactured equipment and had no independent commercial utility.
The Bench relied extensively on the Supreme Court’s landmark judgment in the case of Engineering Analysis Centre of Excellence Pvt. Ltd. v. CIT, which held that payments for use or resale of software do not constitute royalty where no copyright rights are transferred.
After comparing Siemens AG’s software licensing terms with the licensing arrangements examined by the Supreme Court, the Tribunal concluded that the transactions were identical in substance and therefore covered by the apex court’s ruling.
The Tribunal consequently held that software receipts could not be taxed as royalty either under the Income Tax Act or under the India-Germany DTAA.
The Assessing Officer argued that the contract was a composite and indivisible contract and therefore the foreign and Indian entities together constituted an AOP.
However, assessee pointed out that both entities had entered into a Memorandum of Understanding (MoU) clearly defining separate and independent scopes of work. Each party invoiced and received payments independently. There was no common management. There was no sharing of profits or losses. The arrangement specifically stated that it would not constitute a partnership, association, joint venture or similar entity.
The Tribunal referred to the Supreme Court’s decisions in Indira Balkrishna and G. Murugesan & Bros., which lay down that an AOP requires: Joining together by two or more persons; A common design to earn income; Common management; Sharing of profits and losses; and Voluntary coming together for a common purpose.
The Bench further noted the similarity of the case with the Delhi High Court’s ruling in Linde AG, where a consortium formed for execution of a project was held not to constitute an AOP.
The Tribunal also recorded that the DRP had already held that income from offshore supply of equipment was not taxable in India by applying the Supreme Court ruling in Ishikawajma-Harima Heavy Industries Ltd. and the provisions of the India-Germany DTAA.
The department had not challenged that finding before the Tribunal. Consequently, the non-taxability of offshore supplies remained undisturbed.
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