MARCH 28, 2012

Finance Bill 2012 redefines Royalty

By Anand Kakarla, Associate Director and Archana Korlimarla, Manager, PwC India

FINANCE Bill, 2012, has attempted to draw the curtains on the some of the long drawn controversies surrounding the scope and extent of ‘Royalty income' in India. Significant proposals in this direction include bringing the payments towards sale of software and payments for transmissions through satellite within the folds of royalty definition under the Income-tax Act, 1961.

Sale of software:

The proposed amendment, that too with retrospective effect from 1976, tries to explicitly clarify that ‘transfer of all or any right for use or right to use computer software (including granting of a license)' was always to be treated as royalty. The proposed amendment, thereby, attempts to clear the air around this matter which has decades of litigation to its credit right through the Supreme Court.

In October 2011, Karnataka High Court in the case of Samsung Electronics had held that payment for software amounts to ‘royalty' as per Indian tax laws as well as the relevant tax treaty. The High Court was of view that, but for the license, the right to copy would not be available, and therefore that payment has been made for use of copyright, and hence taxable as royalty. Around the same time, Karnataka High Court also held in the case of Lucent Technologies that payment for imported software, which is integrated separately with imported hardware, amounts to royalty in the hands of the non-resident vendor. In rendering this judgement, the High Court did not distinguish between a ‘copyright right' and a ‘copyrighted article' as laid out in the OECD commentary.

However, in December 2011, Delhi High Court in case of Ericsson appreciated this distinction between a ‘copyright right' and a ‘copyrighted article', and held that payment for software imported with hardware was ‘copyrighted article' and not royalty.

Given the conflicting jurisprudence, the Finance Bill, 2012, has proposed to add a clarification regarding the definition of royalty, with retrospective effect from June 1, 1976, as under:

"For 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 license) irrespective of the medium through which such right is transferred"

Such retrospective taxation could severely impact not only import of software from non-residents but also for the domestic procurement of software.

Arguably, the aforesaid amendment to the Income-tax Act, 1961 may not be the end of road as the narrow definition of royalty as per the treaty should still prevail and the tax payers could continue to take refuge under the treaty provisions. However, local procurement of software would now be subject to tax withholding. It only needs to be seen how the revenue authorities would give effect to the retrospective nature of this proposal!

Satellite transmissions:

The Finance Bill, 2012 has proposed to clarify the expression ‘process', which finds place in the royalty definition under the Indian tax laws, as under:

"For 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"

Historically, there have been conflicting tribunal judgements on this issue. In 2002, the Delhi tribunal in case of AsiaSat had held that there was a ‘process' involved in the course of providing Satellite Transmission services to customers, and consequently the payments received would amount to royalty. In 2006, another bench of Delhi tribunal in case of PanAmSat relied on the language of the Indo-US treaty and held that term ‘secret' qualifies ‘process' and hence as there was no ‘secret process' involved in transmission services, the same was not taxable as royalty. However, the case moved up to the Delhi special bench in the case of New Skies Satellites in 2008, where it was held that satellite transmission services amounted to a ‘process' and hence qualifies as royalty both under the Act and the tax treaty. The Special bench had held that the term ‘process' need not be a qualified by the term ‘secret' to fall within the ambit of ‘Royalty'.

This was followed by The Delhi High Court decision in case of AsiaSat which was pronounced in Jan 2011, where it was held that such Satellite transmission services were not royalty since in the first place there was no ‘use' or ‘right to use' granted by AsiaSat to its customers.

Indeed the Satellite operators and other connectivity service providers, especially from non treaty countries, would be impacted with this new development which would result in their incomes being subjected to tax in India as royalty. However, with respect to service providers from Treaty Countries, the narrower definition of royalty as per the treaty could still prevail and the tax payers could continue to take refuge under the treaty provisions.

(The views expressed are personal)