Dr. Avi Nov, Adv.

October, 2011

The Mumbai Income Tax Appellate Tribunal ruled on 26 August 2011 that the supply and license of software constituted the transfer of a copyrighted article, rather than the transfer of a copyright. Consequently, the Tribunal ruled that payments received for the sale of a copyrighted article are not taxable as royalties under the Israel India tax treaty and, therefore, are not taxable in India in the absence of a Permanent Establishment.

The Facts

Team Telecom International Pvt. Ltd. (the Israeli Company), a resident of Israel, entered into an agreement with Reliance Infocomm Limited (the Indian Company) for the supply and license of software for the Indian Company's wireless network in India. Under the agreement, the Israeli Company granted the Indian Company and its affiliates a non-exclusive, royalty-free, worldwide license to install, use, operate or copy the software. The Israeli Company does not have a permanent establishment (PE) in India.

The Israeli Company filed an income tax return in India, and declared zero income since no part of its income should have been taxable in India in the absence of a permanent establishment in India. However, the Indian assessing officer held that the income received by the Israeli Company for the supply of software was in the nature of royalties and, therefore, should have been subject to tax in India.

The appeal

The Israeli Company appealed to the Commissioner of Income Tax. Following the Special Bench decision in the case of Motorola Inc., the Commissioner of Income Tax reversed the assessing officer’s decision, holding that the payment received by the Israeli Company should be considered as a payment for the “purchase of copyright material,” and not constitutes “royalties” within the meaning of article 12(3) of the India-Israel tax treaty.

Upset by the decision, the revenue authorities appealed the Commissioner’s decision to the Mumbai Income Tax Appellate Tribunal.

The Tribunal ruling

The Mumbai Income Tax Appellate Tribunal had to decide whether the payment received by the Israeli Company on account of sale of software and license thereof, qualifies as “Royalties” under Article 12(3) of the India-Israel tax treaty.

The Tribunal held that the definition of "royalty" under Article 12(3) of the India-Israel tax treaty, includes payment for the “use of, or the right to use, any copyright of literary, artistic or scientific work,” and that the “use of any copyright” of a work is distinct from the use of a copyrighted article.

In addition, the context in which the term “process” is used in the next clause in the India-Israel tax treaty means it must be in the nature of know-how and not a product. A payment for software cannot be treated as a payment for a “process.”

Consequently, the Tribunal ruled that payments received for the sale of a copyrighted article are not taxable as royalties under the Israel India tax treaty and, therefore, are not taxable in India in the absence of a Permanent Establishment.

See also:

Israeli Taxation of Computer Software: The Tax Authority Position

Deduction of tax at source from payments to foreign residents

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