Payments received on Application Software & Spare parts are not “Royalty”, not Taxable: ITAT Mumbai [Read Order]

In a recent ruling, the Income Tax Appellate Tribunal, Mumbai has held that the amount received by the assessee on sale of operational/application software and spare parts in the instant case is not exigible to tax since they are not in the nature of “royalty” for the purpose of Income Tax Act, 1961. The question raised before the Tribunal was that whether the payments received by the appellant towards supply of software to the customers in India, as income in the nature of “royalty” within the meaning of Explanation 2(v) of section 9(1)(vi) of the Act and Article 12(3) of the Double Tax Avoidance Treaty between India and Israel and liable to tax in India @ 10% of gross amount.

The assessee has assailed the action of the authorities in holding that the payment received by it towards sale of software as part of machinery, as income in the nature of ‘Royalty’ within the meaning of Explanation 2 of section 9(1)(vi) of the Act and Article 12(3) of the India-Israel DTAA and liable to tax in India @10% of the gross amount.

On behalf of the Revenue, it was contended that if the software was an integral part of the machine, then there was no requirement for the payment to be received separately and for the software to be separately mentioned in the invoices. Since the software was received separately by e-mail, the learned D.R. argued, that it cannot be said that the software was an integral part of the machine.

It was also contended that after the amendment by way of insertion of Explanation 4 to section 9(1)(vi) of the Act by Finance Act 2012 w.e.f. 01.04.1976, the consideration received by the assessee for transfer or sale of computer software would now be covered by the definition of ‘Royalty’ and that since the Explanation has been added with retrospective effect, the case of the assessee is covered by the law as amended and therefore the orders of the authorities below ought to be upheld.

At the outset, the learned A.R. for the assessee submitted that the issue in dispute has been considered in detail and held in favour of the assessee by a Coordinate Bench of this Tribunal in the assessee’s own case for A.Y. 2011-12 in which the Tribunal found the following;

“What was sold by the assessee to the Indian customers was a GSM which consisted both of the hardware as well as the software, therefore, the Tribunal is right in holding that it was not permissible for the Revenue to assess the same under two different articles. The software that was loaded on the hardware did not have any independent existence. The software supply is an integral part of the GSM mobile telephone system and is used by the cellular operator for providing the cellular services to its customers. There could not be any independent use of such software. The software is embodied in the system and the revenue accepts that it could not be used independently. This software merely facilitates the functioning of the equipment and is an integral part thereof”.

Following the decision of the Coordinate Bench of the Tribunal in the assessee’s own case for A.Y. 2011-12 (supra), the Tribunal hold that the amounts received by the assessee on sale of operational/application software and spare parts in the instant case is not exigible to tax as ‘Royalty’ and therefore the addition made by the AO and sustained by the DRP is to be deleted.

Read the full text of the order below.

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