On August 26, an Israeli resident software company, TTI Team Telecom
International Pvt., Ltd. (TTI) of Rosh Ha’ayin scored a victory in the Indian
Income Tax Appellate Tribunal, Mumbai (E Bench, ITA No 3939/Mum/2010, Assessment
TTI is an Israeli resident company that entered
into an agreement with Reliance Infocomm for supply and license of software for
RIL’s wireless network in India. Specifically, the agreement was a “perpetual,
irrevocable, non-exclusive, royalty-free, worldwide license to install, use,
operate or copy the software and the documentation licensed under the agreement
solely for implementation, operation, management and maintenance of RIL’s
Network within India.”
It was agreed that TTI did not have a permanent
establishment (essentially, a fixed place of business) in India. This means TTI
could not be taxed on business profits because it is an Israeli resident company
not doing business in India.
But software is generally protected under
copyright law. Was TTI’s income really royalty income resulting because of the
copyright? The Indian assessing officer certainly thought so and claimed 10
percent royalty withholding tax from all such receipts under Article 12 of the
India-Israel tax treaty.
TTI claimed the software receipts amounted to
“business profits” derived outside India – and hence not taxable at all under
the India- Israel tax treaty, rather than royalties.
Article 12(3) of the India-Israel tax treaty, the term “royalties 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, any patent, trade mark, design or model, plan, secret
formula or process, or for information concerning industrial, commercial or
In this case, the tribunal discussed whether
there is: (1) use of a copyright, or (2) use of a process? With regard to the
first question (use of a copyright), the tribunal distinguished between “use of
copyright” and “use of a copyrighted article.”
This is taken from US law,
and in fact the tribunal was influenced by another case involving Motorola,
(Motorola Inc. vs DCIT, 96 TTJ 1).
For example, when a person is using a
music compact disc, that person is using the copyrighted article (i.e., the
product itself) and not the copyright in that product.
To constitute “use
of a copyright,” the transferee must enjoy four rights: (1) the right to make
copies of the software for distribution to the public, (2) the right to prepare
derivative computer programs based upon the copyrighted program, (3) the right
to make a public performance of the computer program, and (4) the right to
publicly display the computer program. If none of these rights are enjoyed by
the purchaser, as in this case, there is no “use of a copyright.”
the second question (use of a process), the tribunal ruled that the
consideration received by TTI is not for “use of a process,” because what the
buyer is paying for is not for the “process” but for the “results” achieved by
use of the software. In fact, under the standard terms and conditions for sale
of the software, the buyer is not even allowed to tinker with the process on the
basis of which such software runs, or even to work around the technical
limitations of the software. It would be a “hyper-technical approach totally
divorced from ground business realities” to hold that the use of software is use
of a “process.”The tribunal’s decision
The tribunal ruled that the
software receipts were not royalties under the India-Israel tax
Instead, the receipts were business profits derived outside
India. Therefore no Indian taxes applied to the software receipts in this
Israeli software firms and other hitech firms that export
their products should always beware of business profit taxation and/or royalty
withholding tax in each country concerned.
Royalty withholding tax is a
tax on sales receipts even if the firm has tax losses in Israel (for example,
from research and development).
Therefore, Israeli hi-tech firms should
check carefully: (1) their contractual terms of business, (2) where and how they
do business, and (3) local tax laws in each country.
In this case, a
positive Indian precedent was set for Israeli software firms and firms from
other countries that have a similar tax treaty with India. Nevertheless, Indian
tax law and case decisions are constantly evolving and should be
monitored.As always, consult experienced tax advisers in each country at
an early stage in specific firstname.lastname@example.org Leon Harris is a certified
public accountant and tax specialist at Harris Consulting & Tax Ltd.