Tc/2184/2006 Of M/S.zylog Systems Ltd v. The Income Tax Officer

IN THE HIGH COURT OF JUDICATURE AT MADRAS DATED: 23.4.2019 THE HON'BLE DR.JUSTICE VINEET KOTHARIANDTHE HON'BLE MR.JUSTICE C.V.KARTHIKEYAN Tax Case Nos.2184 & 2185 of 2006M/s.Zylog Systems Limited,82/40, I Main Road, CIT Nagar,Nandanam, Chennai 600 035... Appellant in both cases The Income Tax Officer,International Taxation II,Chennai-34.cases .. Respondent in both Tax Case Appeals filed under Section 260A of the Income TaxAct, 1961 against the order of the Income Tax AppellateTribunal, Madras 'B' Bench, Chennai, dated 27.1.2006 made in ITANos.2082/Mds/2005 & 2083/Mds/2005 for the Assessment Year 2001-02, 2002-03 against the order of the Commissioner of Income Tax(Appeals)-XI, Chennai 34 dated 31.08.2005 and made inI.T.A.No.340/2004-05 and for the Assessment Year 2001-02, 2002-03. Against the order of the Income Tax Officer(InternationalTaxation)-II, Chennai dated 10.08.2004 and made inG.I.No/P.A.No.AAACZ1086G for the Assessment Year 2001-02 and2002-03. The Assessee M/s.Zylog Systems Limited, Chennai now said tobe in Liquidation, had filed these Tax Cases under Section 260-Aof the Income Tax Act, by raising the following purportedsubstantial questions of law arising from the order passed bythe Income Tax Appellate Tribunal dated 27.1.2006, by which the https://hcservices.ecourts.gov.in/hcservices/ learned Tribunal dismissed the Appeal filed by the Assessee forthe Assessment Years 2001-02 and 2002-03 and upheld the orderspassed by the Appellate Authority. 2. The questions on which the present Tax Cases had beenadmitted by a coordinate Bench of this Court are quoted belowfor ready reference:- "i) Whether the Tribunal was right in holding thatthe interest levied under Section 201(IA) is legallyvalid having regard to the provisions of the IncomeTax Act and the Double Tax Avoidance Agreemententered into between Indian and USA?ii) Whether the Tribunal was right in law in holdingthat the appellant has to deduct tax at source sincethe payment constituted Royalty?"3. The facts in brief are as under:- The Assessee-Company is engaged in the business ofdevelopment of Software. The Assessee entered into a LicenceAgreement with M/s.Bluestone Software Inc. for getting a licenceto use Bluestone's Total e-Business and Universal BusinessServer, Universal Listener Framework, Scheduler, XMLServer andVisual XML development. The assessee has paid a sum of US$3,00,000 which is equivalent to Indian Rs.1,38,57,2501- towardslicence fee. The Assessing Officer treated this payment of US$3,00,000 as Royalty and also treated the Assessee a Assessee-in-default under Section 201( 1) of the Income Tax Act. TheAssessing Officer has also levied interest under Section 201(IA)of the Income Tax Act. The Assessee, being aggrieved by theorder of the Assessing Officer, filed an appeal before the CIT(A). The CIT(A), after elaborately discussing the issue,confirmed the order of the Assessing Officer. Therefore, theAssessee filed Appeals before the Tribunal. 4. The learned Tribunal decided the issue against theAssessee and held that the payment made by the Assessee to theUS Company was a payment of 'Royalty' for use of Copyrights,Software and Logo of US Company and was covered by Article 12 ofthe Double Tax Avoidance Agreement (DTAA) between India and USAand therefore, the Assessee, an Indian Company was liable todeduct tax ii1t sourc,e and pay the same to the State. Onaccount of non-deduction of tax and deposit with the Treasury,the Authorities below also imposed interest under Section 201(IA) of the Act. The relevant portion of the order passed by thelearned Tribunal in this regard, is quoted below for readyreference: -"19. We have considered the rival submissions oneither side, and also perused the material availableon record. Admittedly, the assessee entered into anagreement with a foreign company M/s. BluestoneSoftware Inc. Clause 1.4 of the agreement reads asfollows: "1.4 License to Use BluestoneTrademark/ServiceMarks. Bluestone grants to Licensee a worldwide, non-exclusive, non-transferable license to use thetrademarks, service marks, notices, and/or logosof Bluestone which are set forth on Exhibit F(which may be updated from time to time by anagreement of the parties) solely to indicate thatthe Applications contain the Licensed Productsand/or for any other purpose specificallyauthorized by this agreement." 20. From the above clause in the agreement it is veryclear that the assessee was given the right to usetrademark and logo of the foreign companyMls.Bluestone Software Inc. in order to market thecommodity as Licensed Product of Mis. BluestoneSoftware Inc. Therefore, the assessee was given aright to use the trademark by the foreign company forwhich the assessee has to pay the amount annually.Clause 1.1 of the agreement reads as follows: "1.1 License to Develop Applications. Bluestonegrants Licensee a worldwide, nonexclusive, non-transferable license to copy, install, test anduse the Licensed Products listed on Exhibit Aat the Authorized Location to develop,reproduce, market, license and support theApplications listed on Exhibit A."21. This clause authorises the assessee to copy theproduct listed on Exhibit A and to reproduce the sameor develop the same. Therefore, the agreement betweenthe assessee and the foreign company is not only touse the copy of a copyright of software but to takecopies and to develop the same and they are alsopermitted to market the product with a trademark andlogo of the foreign company. For the purpose of thisauthorisation to use the software, trademark and logoin the product, the assessee is paying the annualfee. Therefore, the question arises for considerationis whether the annual fee paid by the assessee forusing the software, trademark and logo would amountto payment of royalty. 22. The contention of the assessee before thisTribunal is that the definition given in Section 9(1)(vi) of the Income Tax Act is very wide, therefore,we have to take the definition given in the DoubleTaxation Avoidance Agreement entered into betweenIndia and United States of America. The assessee hasproduced a copy of the Double Taxation AvoidanceAgreement entered into between India and UnitedStates of America. Article 12(3) defines royalty as follows:"The term "royalties" as used in the Articlemeans:(a) payments of any kind received as aconsideration for the use of, or the right touse any copyright of a literary, artistic orscientific work, including cinematograph filmsor work on film, tape or other means ofreproduction for use in connection with radio ortelevision broadcasting, any patent, trademark,design or model, plan, secret formula orprocess, or for information concerningindustrial commercial or scientific experience,including gains derived from the alienation ofany such right or property which are contingenton the productivity, use, or dispositionthereof, and (b) payment of any kind received asconsideration for the use of, or right to use,the industrial, commercial, or scientificequipment other than payments derived by anenterprise described in paragraph 1 of Article 8(Shipping and Air Transport) from activitiesdescribed in paragraph 2(c) or 3 or Article 8." 23. From a bare reading of the above definitiongiven in the Double Taxation Avoidance Agreement,it is very obvious that any payment received asconsideration for use of or right to use copyrightor an artistic work or a trademark design or planwould amount to royalty within the meaning ofArticle 12(3) of the Double Taxation AvoidanceAgreement. In. this case, what was paid by theassessee as an annual fee is for the use ofsoftware which gives a right to use, copy developand market the same by using the trademark and logoof Mls.Bluestone Software Inc. Therefore, thepayment made by the assessee as annual fee would befor the purpose of using the software for copyingand developing and also for using the trademark orlogo for marketing the product in Indian market.Therefore, in our opinion, the payment of annualfee by the assessee to Mls.Bluestone Software -Inc. squarely falls within the definition "royalty"as provided in Article 12(3) of the Doubt TaxationAvoidance Agreement. Therefore, we do not find anysubstance in the argument of the learnedrepresentative of the assessee that the payment isnot in the form of royalty. 24. The other contention of the learnedrepresentative for the assessee is that the recipient Mls.Bluestone Software Inc. is not liableto pay any tax since the payment does not havecharacteristics of royalty. Since we have concludedthat the payment has the characteristics of royaltywithin the meaning of Article 12(3) of the DoubtTaxation Avoidance Agreement, in our opinion, thiscontention of the assessee is baseless. Therefore,the payment is liable to be taxed in India. In viewof the above, the assessee ought to have deductedtax as provided in Section 195 of the Income TaxAct. 25. We have also carefully gone through theprovisions of Sec.9(1)(vi) of the Income Tax Act.As rightly submitted by the learned representativefor the assessee, the definition given in Section 9(1)(vi) of the Income Tax Act is very wide in orderto cover any payment relating to any right ofproperty or information used for the purpose ofbusiness. As we have already observed, the paymentof annual fee falls even within the restrictedmeaning given in Article 12(3) of the DoubleTaxation Avoidance Agreement. Since a right to copyand develop the software and to use the trademarkwas given to the assessee in their business, thepayment would definitely fall within the definitionof Section 9(1)(vi) of the I. T. Act also apartfrom the definition given in article 12(3) ofDouble Taxation Avoidance Agreement. Therefore, theinescapable conclusion would be that the annual feepaid by the assessee is a royalty, therefore, is noquestion of any doubt regarding deduction of tax. 26. Let us now examine the case laws relied uponby the learned representative for the assessee. Thefinal case relied upon by the learnedrepresentative is of the Bangalore Bench of thisTribunal in the case of Samsung Electronics CompanyLtd. (supra). We have carefully gone through thedecision of the Bangalore Bench of this Tribunal.In the case before the Bangalore Bench, theassessee a branch of Samsung Electronics Co. Ltd.,Korea engaged in the development, manufacture andexport of software for use of its parent company.The software developed by the assessee is for in-house use by the parent company. The assesseeimported software product from Tektronix Inc., USA.The assessee has also imported software productfrom France and Sweden. The assessee contendedbefore the Bangalore Bench of this Tribunal thatthe software imported by the assessee are readilyavailable in market, therefore, the payment made to software company cannot be treated as royalty. Inthose factual situations, the Bangalore Bench ofthis Tribunal found that under Double TaxationAvoidance Agreement, the consideration paid must befor use or right to use any copyright of literaryor artistic or scientific work. The Bangalore Benchfound that the assessee has received only a copy ofthe copyright article and the incorporeal right tosoftware remained with owner. Therefore, theBangalore Bench concluded that the assessee hadmerely purchased a copy of the copyright article,therefore, the payment does not fall within the.meaning of royalty as provided in Double TaxationAvoidance Agreement. In the case before us/ as peragreement between the assessee and the foreigncompany Mls.Bluestone Software Inc., clause 1.1 ofthe Agreement specifically gives a right to copythe licensed product and develop and reproduce thesame for marketing. Clause 1.4 of the Agreementauthorises the assessee to use the trademark andlogo in the product developed or reproduced by theassessee for marketing. Therefore, in the casebefore us/ it is not a purchase of mere software asin the case of foreign company. In the case beforeus/ a right to copy/ develop and reproduce the samewas specifically given by clause 1.1 of theAgreement. Therefore, in our opinion, the decisionof the Bangalore Bench of this Tribunal is notapplicable to the facts of this case. 27. The next case relied upon by the learnedrepresentative for the assessee is the judgment ofthe Kerala High Court in the case of Fertilisers &Chemicals Travancore Ltd. (supra). The learnedrepresentative relied upon by this judgment for theproposition that the assessee has to deduct taxwhen the sum payable to the foreign company ischargeable under the Income Tax Act. As we havealready discussed, we concluded that the payment isa royalty, therefore, it is liable for taxationunder the Income Tax Act. Therefore, as held by theKerala High Court, the assessee has to deduct taxwhen the amounts were paid to the foreign company.For the very same proposition, the learnedrepresentative for the assessee placed his relianceon the judgment of the Karnataka High Court in thecase of Hyderabad Industries Ltd. (supra) anddecision of the Hyderabad Bench of this Tribunal inthe case of SOL Pharmaceuticals Ltd. (supra). Thejudgment of the Madras High Court in the case ofNeyveli Lignite Corporation Ltd. (supra) is with regard to the payment made by the assessee under acomprehensive contract for design, manufacture,supply and erection etc. and not for any license,patent, model and design. In this case, admittedly,the license was to copy, develop and reproduce thesoftware and market the same with trademark andlogo of the foreign company, therefore, in ouropinion, this judgment of the Madras High Court isalso not applicable to the facts of this case. regard to the payment made by the assessee under acomprehensive contract for design, manufacture,supply and erection etc. and not for any license,patent, model and design. In this case, admittedly,the license was to copy, develop and reproduce thesoftware and market the same with trademark andlogo of the foreign company, therefore, in ouropinion, this judgment of the Madras High Court isalso not applicable to the facts of this case. 28. Now coming to explanation to Section 191, inview of our conclusion that the payment wasrelatable to royalty within the meaning of DoubleTaxation Avoidance Agreement, irrespective ofexplanation to Section 191 the assessee is liableto deduct tax. Therefore, it may not be necessaryfor this Tribunal in this case to go into theexplanation to Section 191 and find out whether itis retrospective in operation or prospective inoperation. 29. Now coming to charging of interest underSection 201(IA), the contention of the assessee isthat the interest has to be computed from the dateon which tax was deductible to the date on whichtax was actually paid. Since, the tax was notdeducted and tax was not paid, it is notpracticable to calculate interest on the basis ofprovisions of Sec.201(IA). We have also carefullygone through the decision of this Tribunal in thecase of Anusha Investments Ltd. (supra). There isno dispute that the charging section andcomputation procedure provided in the machineryprovision constitute an integrated code. When theincome could not be computed as per the machineryprovisions provided under the Act, there cannot beany levy of tax. In this case, it is not acomputation of income. It is a levy of interest fornon deduction and non payment of tax. When theassessee has not deducted the tax and paid the sameto the Government account, the assessee is liableto pay interest from the date on which the taxrequired to be deducted and the date on which thetax was actually paid to the Government account.Therefore, in our opinion, there is no difficultyin computing the interest when the assessee has notdeducted the tax as provided under the Act. Theperson, who has not complied with the provisions ofIncome Tax Act cannot be in a better position thana person who complied with the provisions of IncomeTax Act by deducting the tax at source and paid thesame to the Government account. In view of the above, we do not find any substance in the argumentof the learned representative for the assessee onthis issue also. In our opinion, the decision ofthis Tribunal in the case of Anusha InvestmentsLtd. (supra) may not be of any assistance to theassessee. 31. In view of the above discussion, it is notnecessary to discuss the other case laws reliedupon by the learned representative for theassessee. In view of the foregoing discussion, wehold that the payment of annual fee and maintenancecharges are in the nature of royalty, therefore,the assessee is liable to deduct tax under Section195 of the Income Tax Act. Accordingly, we upholdthe orders of the lower authorities. 32. In the result, both the appeals filed by theassessee stands dismissed. However, there will beno order as to cost." 5. Learned counsel for the Revenue Mr.Karthik Ranganathansubmitted that a Division Bench of Karnataka High Court dealtwith the similar controversy in the case of CIT v. SynopsisInternational Old Ltd. ((2012) 28 taxmann.com 162 (Kar.) andheld, after detailed discussion, that such payments made by theIndian Company to the Foreign Company amounted to payment ofRoyalty and the Indian Company was liable to deduct tax atsource on such payment of Royalty made by the Indian Company tothe Foreign Company. The relevant portion of the decision of theDivision Bench of the Karnataka High Court, with which werespectfully agree, is extracted as under:- 32. In the result, both the appeals filed by theassessee stands dismissed. However, there will beno order as to cost." 5. Learned counsel for the Revenue Mr.Karthik Ranganathansubmitted that a Division Bench of Karnataka High Court dealtwith the similar controversy in the case of CIT v. SynopsisInternational Old Ltd. ((2012) 28 taxmann.com 162 (Kar.) andheld, after detailed discussion, that such payments made by theIndian Company to the Foreign Company amounted to payment ofRoyalty and the Indian Company was liable to deduct tax atsource on such payment of Royalty made by the Indian Company tothe Foreign Company. The relevant portion of the decision of theDivision Bench of the Karnataka High Court, with which werespectfully agree, is extracted as under:- "45. As is clear from the description of theagreement it is an end-user software licenceagreement. Clause 2.1 deals with grant of rights. Itprovides, Software License Synopsys hereby grantslicencee a non-exclusive, nontransferable license,without right of sub-licence of use the licensedsoftware and design techniques only in the quantityauthorized by a licensee in accordance with thedocumentation in the use area. Licensee may make areasonable number of copies of the licensed softwarefor backup and/or archival purposes only. Merelybecause the words non-exclusive and non-transferableis used in the said licence it does not take away thesoftware out of the definition of the copyright. Theword licenced software has been defined. Similarly,the words design, design technique is also defined.The word documentation is also defined and it is notin dispute what is granted is a license. Even if itis not transfer of exclusive right in the copyright,the right to use the confidential informationembedded in the software in terms of the aforesaid licence makes it abundantly clear that there istransfer of certain rights which the owner ofcopyrightpossessinthesaidcomputersoftware/programme in respect of the copyright ownedin terms of the DTAA the consideration paid for theuse or right to use the said confidential informationin the form of computer programme software itselfconstitutes royalty and attracts tax. It is notnecessary that there should be a transfer ofexclusive right in the copyright as contended by theassessee. The consideration paid is for rights inrespect of the copyright and for the user of theconfidentialinformationembeddedinthesoftware/computer programme. Therefore it fallswithin the mischief of Explanation (2) of clause (vi)of subsection (1) of section 9 of the Act and thereis a liability to pay the tax. 46. If there was any doubt regarding the taxabilityof this income the parliament by Finance Act, 2010has substituted the explanation to section 9 whichgives a clear intention of the legislature insofar asthe liability of tax under this provision isconcerned. A perusal of the said explanation makes itclear that as there was a doubt earlier, they want toremove the doubts by introducing this explanation. Bythe explanation they have declared that for thepurpose of section 9 which deals with income deemedto accrue or arise in India, under clauses (v), (vi)and (vii) of sub-section (1), such income shall beincluded in the total income of the non-resident,whether or not (i) the non-resident has a residenceor place of business or business connection in India,(ii) the non-resident has rendered services in India.Therefore, the object is to levy tax on the income ofa non-resident, if it has accrued or arisen in Indiaand one such income is the income from royalty. In the result, we pass the following:- ORDER ORDER (a) All the appeals are allowed.(b) Impugned orders passed by the Income TaxAppellate Tribunal, Bangalore Bench, is hereby setaside. (c) The order passed by the Commissioner of IncomeTax (Appeals) affirming the order passed by theAssistant Commissioner of Income Tax, Circle 19(1),Bangalore, with modification is restored. (d) No costs."6. We may note here that the Karnataka High Court dealt withthe case of M/s.Samsung Electronics Co. Ltd. v. ITO ((2005) 94ITD 91 (Bang.)), which was distinguished by the learned https://hcservices.ecourts.gov.in/hcservices/ Tribunal, in para 26 of the impugned order. 7. The learned Official Liquidator for the Assessee couldnot controvert the aforesaid submission of the learned SeniorStanding Counsel for the Revenue. 8. Having gone through the judgment of the Karnataka HighCourt and the order impugned of the learned Income Tax AppellateTribunal, we agree with the view taken by the Karnataka HighCourt on the issue that the payments made by the AssesseeCompany to the US Company for user of its Software, Logo andTrade Marks were in the nature of Royalty covered under Article12 of the Double Tax Avoidance Agreement (DTAA) between Indiaand USA and therefore, the Assessee, Indian Company was liableto deduct tax at source and pay the same to the State. Onaccount of its failure to do so, it was also liable to payinterest thereon under Section 201(IA) of the Act. 9. Thus, we do not find any merit in the present Appealsfiled by the Assessee and the same are liable to be dismissedand accordingly, the same are dismissed. The questions framed,as quoted above, are answered against the Assessee and in favourof the Revenue. No order as to costs. Sd/- Assistant Registrar(CCC) //True Copy// Sub Assistant Registrarssk.To 1. The Income Tax Officer, International Taxation II, Chennai-34 2. Income Tax Appellate Tribunal, Madras 'B' Bench, Chennai. 3.The Commissioner of Income Tax(Appeals)-XI, Chennai 34. +1 cc to Mr.S.Gopalakrishnan, Advocate, Sr.No. 39641 +1 cc to M/s.Karthik Ranganathan, Advocate, Sr.No. 38437 sv(co)CSL/06.06.2019 T.C.Nos.2184 & 2185 of 2006 https://hcservices.ecourts.gov.in/hcservices/