H P Agrawal: Sale of software under tax treaty

FOREIGN ENTERPRISES

A scrutiny of the legal position prevailing under the Income-Tax Act will show that when a foreign company transfers a computer software in India in a manner that the purchaser acquires full or partial copyrights, such a transaction should be treated as a sale rather than a transaction involving royalty or fees for technical services (The Lucent Technologies Hindustan Ltd vs Income Tax Officer case, 270 ITR 62 (AT)).

Therefore, a foreign enterprise, which transfers the software will be liable to pay tax in India only if the said foreign enterprise has a permanent establishment in India and further the profits on the said transaction are attributable to the India permanent establishment (Article 7 of Tax Treaties).

In this context, a special reference is necessary to the tax treaty between India and the US. Paragraph 4(b) of Article 12 of the treaty provides that payment in consideration for the rendering of any technical or consultancy services shall be treated as "fees for included services" if such services make available technical knowledge, experience, skill, know-how, or processes, or consist of the development and transfer of a technical plan or technical design.

Further, the explanation of this paragraph 4(b), as given in the MoU annexed to the tax treaty, reads: "Typical categories of services that generally involve either the development and transfer of technical plans or technical designs, or making technology available as described in the paragraph 4(b), includes computer software development".

A plain reading of the MoU suggests that when a US firm undertakes computer software development for an Indian enterprise, payment made by the Indian enterprise for the computer software shall be regarded as "fees for included services".

It is obvious that the explanation as contained in the MoU is in conflict with the legal interpretation, which the courts have made in India. But wherever there is a conflict between the domestic law and the tax treaty the provision, which is more beneficial to a taxpayer will be applicable. (The Union of India vs Azadi Bachao Andolan case, 263 ITR 706 (SC))

Therefore, even assuming that under the US tax treaty development of software is taxable as fees for included services, the interpretation of Indian courts will prevail, and accordingly the transferor of software will not be liable to pay tax in India.

There is yet another angle to the interpretation of the US tax treaty. The US tax treaty was signed in 1989. Subsequent to the signing of the treaty, the OECD Model Tax Convention was amended particularly relating to Article 12, which deals inter alia with computer software.

The amendment made by the OECD on April 29, 2000, specifically mentions about the rapid development of computer technology and transfer of such technology across national borders necessitating amendment to the then existing commentary.

Paragraph 15 of the OECD commentary on Article 12 states that where payment is made for alienation of ownership rights in computer software, in full or in part, the consideration cannot be considered as royalty. It is significant to note that the US is a signatory to the OECD Tax Convention.

Therefore, the MoU of the Indo-US tax treaty, which even otherwise is only intended to give guidance, should not be taken to be so sacrosanct that it will override the provisions of law.

agar@nda.vsnl.net.in