Micro Focus Ltd. vs DCIT International Taxation: Royalty Taxation Dispute – ITA 6604/DEL/2019

Micro Focus Ltd. vs DCIT International Taxation: Royalty Taxation Dispute – ITA 6604/DEL/2019

This case involves an appeal filed by Micro Focus Ltd., a United Kingdom-based software company, against the order passed by the Commissioner of Income Tax (Appeals)-43, New Delhi. The appeal pertains to the assessment year 2015-16 and was heard by the Income Tax Appellate Tribunal (ITAT), Delhi Bench ‘D’. The final order was pronounced on 20th May 2022.

Background of the Case

Micro Focus Ltd. is a company incorporated in the United Kingdom, engaged in the business of developing and distributing software products globally. The company sells its software products in India either through distributors or directly to customers. According to the appellant, all sales are conducted outside India on a principal-to-principal basis, and the company does not have any physical presence in India, such as offices, project offices, or godowns.

The central issue in this case was whether the revenue received from the sale of software to Indian customers should be taxed as ‘royalty’ under the India-UK Double Taxation Avoidance Agreement (DTAA), or whether it should be treated as business income not liable to tax in India due to the absence of a Permanent Establishment (PE).

Key Issues and Grounds of Appeal

The primary ground of appeal raised by Micro Focus Ltd. was whether the receipts from the sale of software products to Indian customers should be classified as ‘royalty’ under the provisions of the India-UK DTAA and thus be subject to taxation in India. The appellant argued that the income should not be considered as royalty and should instead be treated as business income, which is not taxable in India in the absence of a PE.

This issue had been previously contested in earlier assessment years, where the ITAT had consistently ruled in favor of Micro Focus Ltd., concluding that such income was not taxable as royalty.

Tribunal’s Findings and Decision

The ITAT carefully reviewed the arguments presented by both the appellant and the respondent. The appellant’s counsel highlighted that similar issues had been resolved in the appellant’s favor in earlier assessment years, specifically from AY 2008-09 to AY 2011-12 and AY 2013-14 to AY 2014-15. In those instances, the ITAT had ruled that the income from the sale of software products was not liable to tax under the ‘royalty’ head.

Additionally, the appellant referenced the Supreme Court’s decision, which affirmed the ITAT’s earlier rulings, reinforcing that the income from such sales could not be classified as royalty under the India-UK DTAA.

Classification of Income from Software Sales

The core of the dispute was whether the revenue received from the sale of software to Indian customers constituted royalty. The ITAT considered the definition of royalty under both Indian tax law and the India-UK DTAA. It reiterated that the sale of software products by the appellant did not involve the transfer of any rights to use a copyright; rather, it was the sale of copyrighted software itself. Therefore, the revenue should not be taxed as royalty.

The tribunal also noted that the Supreme Court had already addressed this question in the appellant’s favor, providing a binding precedent. Given that the facts and circumstances for AY 2015-16 were identical to those in the earlier years, the ITAT saw no reason to depart from the established rulings.

Conclusion

In its final order, the ITAT ruled in favor of Micro Focus Ltd., affirming that the income from the sale of software to Indian customers for the assessment year 2015-16 could not be taxed as royalty under the India-UK DTAA. The tribunal directed the Assessing Officer to treat the revenue as business income, which is not taxable in India due to the absence of a PE.

This decision aligns with the ITAT’s and Supreme Court’s previous rulings, reinforcing the principle that the sale of copyrighted software, without transferring the right to use the copyright, does not constitute royalty. The ruling in ITA 6604/DEL/2019 underscores the importance of consistency in tax treatment and the need to adhere to established legal precedents.

Micro Focus Ltd. vs DCIT International Taxation: Royalty Taxation Dispute – ITA 6604/DEL/2019