Can Consideration Received For Supply Of Software embedded in hardware treated as Royalty for Income Tax?

Dy. Commissioner of Income Tax v/s Park Air Systems Ltd.

(Order pronounced in the open court on 07/06/2022)

The assessee is a UK-registered company hence a tax resident of United Kingdom, working in the area related to advanced air traffic control systems and is engaged in the design, manufacture and installation of ground-based systems for use in air traffic control and air defence applications. The assessee e-filed its return of income on 28/09/2016 declaring total income of Rs. Nil and claimed refund of Rs 1,41,22,180. During the year under consideration, assessee received payments from Airport Authority of India under purchase order for supply of transmitters and receivers with accessories. The total consideration payable to the assessee, under the above purchase order, was Rs. 37,73,37,226.

During the assessment proceedings, assessee was asked to show cause as to why receipt of Rs. 9,41,23,330, under purchase order Park Air Systems Ltd. issued by Airport Authority of India, for offshore supply of software should not be considered as Royalty under section 9(1)(vi) of the Act read with Article 13(2) of the India and UK Double Taxation Avoidance Agreement. Assessee submitted that the software so supplied is embedded in the hardware and such software are neither to be supplied separately nor does it have any independent existence, hence in the nature of goods forming an integral part of the hardware system and thus, no tax would be payable in India in respect of such software supplied along with the hardware.

The Assessing Officer did not agree with the submissions of the assessee and treated the consideration received for supply of software as Royalty under the provisions of the Act as well as DTAA.

Appeal before CIT(A):  The learned CIT(A) by placing reliance upon the decision of Hon’ble Supreme Court in Engineering Analysis Centre of Excellence Pvt. Ltd. vs CIT: [2021] 432 ITR 471 (SC), allowed the appeal filed by the assessee and deleted the addition made in respect of payment received for supply of software, Park Air Systems Ltd. which was embedded in hardware.

Appeal before Tribunal: Being aggrieved, Revenue is in appeal before the Tribunal. Tribunal observed that in DIT vs Ericsson A.B. [2012] 343 ITR 470 (Del), wherein the taxpayer supplied various equipment (hardware) embedded with software to the Indian cellular Park Air Systems Ltd operators Hon‟ble Delhi High Court held that payment received by the taxpayer towards GSM system of which software was an inseparable part, which is incapable of independent use, could not be classified as payment towards Royalty. The aforesaid decision in Ericsson AB (supra) was subsequently followed by Hon‟ble Delhi High Court in DIT vs Nokia Networks OY [2013] 358 ITR 259 (Delhi) and CIT vs ZTE Corporation [2017] 392 ITR 80 (Delhi), in which it was held that, “We have to keep in mind 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.”

Thus, the tribunal which keeping in mind the above legal position, held that the learned CIT(A) was correct in the present case, and found no infirmity in the impugned order. Hence, appeal by the Revenue was dismissed.

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