Income Tax Appellate Tribunal - Delhi
Adit, New Delhi vs M/S Nortel Networks Singapore Pte. ... on 24 April, 2018
IN THE INCOME TAX APPELLATE TRIBUNAL
DELHI BENCH 'G' NEW DLEHI
BEFORE SHRI G.D. AGRAWAL, PRESIDENT
AND
SHRI K. NARASIMHA CHARY, JUDICIAL MEMBER
I.T.A. Nos. 2172 to 2176/Del/2011
Assessment Years: 2001-02 to 2005-06
Addl. Director of Income-tax vs M/s Nortel Networks Singapore P. Ltd,
Circle 2(1), New Delhi. C/o S.R. Batliboi & Co.
Golf View, Corporate Park, Tower B,
Sector 42, Gurgaon.
(PAN: AACCN0752F)
I.T.A. Nos. 2757 to 2760/Del/2009
Assessment Years: 2001-02 to 2005-06
M/s Nortel Networks Singapore P. Ltd, vs Dy. Director of Income-tax
C/o S.R. Batliboi & Co. Circle 2(1), New Delhi
Golf View, Corporate Park, Tower B,
Sector 42, Gurgaon.
(PAN: AACCN0752F)
(Appellant) (Respondent)
Assessee by:
S/Shi Nagwshwar Rao, Purushottam Ananad
Ms Sherry Goyal
Department by: Shri G.K. Dhall, CIT DR
Date of hearing: 22.03.2018
Date of Pronouncement: 24 .04.2018
2
ORDER
PER K. NARASIMHA CHARY, JM
These appeals are preferred by the revenue and the assessee respectively challenging the order dated 27.02.2009 of the learned Commissioner of Income- tax (Appeals)-XXIX, New Delhi (for short "CIT(A))".
2. Brief facts of the case are that the Assessee M/s Nortel Networks Singapore P. Ltd, is a company incorporated under the laws of Singapore. It is engaged in the business of supplying advanced the networking technologies to customers in the Asia-Pacific region. Its system knowledge encompasses key products required in telecommunication networks, such as digital exchanges, transmission systems and base stations which include both the hardware and software, which is an embedded software in some instances. Nortel Networks India private limited ("Nortel India"), is a group company of the assessee in India established in July, 1996 in India and provides market support and licensing services to the assessee under the service agreement. The Indian entity NNIPL carried out installation and onshore supplies portion of various contracts with Indian buyers. NNIPL also provides support services under a written agreement and has been remunerated on cost plus basis. It was also subjected to transfer pricing scrutiny by Indian tax authorities. Nortel Networks India International Inc (NNIII) is a USA Inc entity which makes offshore supplies to Indian buyers under contracts assigned by the Indian entity. In addition to NNIII and NNIPL, the Canadian parent company of Nortel group had a liaison office in India which carried out activities permitted by the Reserve Bank of India.
33. During the previous years relevant to the assessment years 2001-02 to 2004-05, the assessee supplied telecommunication equipment with or without related software to the following Indian telecom operators:-
Name of the AY 2001-02 AY 2002-03 AY 2003-04 AY 2004-05 AY 2005-06 customer (amount in (amount in (amount in (amount in (amount in USD) USD) SGD) USD) SGD) Bharti Telesonic 2,347,653 5,316,582 12,468,821 11,470,201 9,696,382 Ltd. (Bharti) Reliance - - 18,203,175 3.374,105 2,09,891 Infocomm Ltd.
(Reliance BPL Cellular Ltd. 344,722 1,562,835 206,157 - -
Gas Authority of - 4,125,772 4,185,026 - - Inida Ltd. (GAIL) Videsh Sanchar 264,783 22,292 96,879 - - Nigam Ltd.(VSNL) Total 2,957,158 11,007,481 35,160,058 14,844,306 9,906,273
4. Return of income for the assessment year 2003-04 was picked up for scrutiny under section 143 (2) and as could be seen from the Assessment Order, Ld. AO observed that Nortel India and the liaison office of Nortel Networks Ltd, being a Nortel group companies, were actually involved in negotiation and conclusion of contracts on behalf of the assessee in India; Nortel India was involved in securing orders wholly on behalf of the assessee and other Nortel group companies in India; both Nortel India and the Indian liaison office were operating from the same premises; Nortel India was financially and technically dependent on the assessee and other Nortel group companies; the assessee undertook the responsibility for successful completion of the installation contracts; and the employees of the assessee remained in India and rendered services to Nortel India for more than 30 days in a fiscal year. Basing on these 4 observations, Ld. AO held that the supply of hardware has resulted in income, which is taxable in India as per Article 5 of the tax treaty since the assessee has a PE in India in the form of its liaison office and the Indian group company - Nortel India.
5. Ld. AO taxed the income from supply of software as 'Royalty' under the provisions of Article 12 and section 9(l)(vii) of the Act. According to the Ld. AO, the payment received by the assessee in respect of supply of software is a payment in respect of use of a copyright since under the Indian Copyright Act, 1957 sale of a computer programme (software is a computer programme) is a sale of a copyright; use of a secret formula or process as use of a software involves a series of steps within it before it gives the desired results; use of a information concerning industrial, commercial and scientific experience as software includes such information; and use of a trademark as a trademark is involved in such software.
6. While determining the income accruing to the appellant from hardware supply, the Assessing Officer has arbitrarily considered 55% of the total supply revenues as attributed to hardware supply and applied a gross profit margin of 42.6% (being the gross profit margin disclosed in the audited accounts of Nortel Networks Ltd., being a Nortel group company) on the entire hardware sales to the Indian telecom operators. 40% of the total supply revenues have been arbitrarily attributed to software supply and taxed at the rate of 20% (on a gross income basis) under the provisions of section 115 A read with section 44D of the Act.
57. Subsequently after issuing notice under section 147 of the Act for assessment years 1999-2000 to 2002-03 and after scrutiny of the returns of income, the assessing officer passed the order holding that there is PE of the assessee in India and taxable income from supply of hardware and software for assessment years 2001-02 and 2002-03. Similar order was passed in respect of the assessment years 2004-05 and 2005-06 also.
8. In appeal, for all these years, by way of a common order dated 27/02/2009 for the assessment years 2001-02 to 2005-06 learned CITA observed that the assessee has a PE and business connection in India in the form of Nortel Networks India private limited and the liaison office of parent Nortel Networks Ltd, Canada; the employees of the assessee or other personnel carried out the business of the assessee through the premises of the LO or the premises of the subsidiary; the assessee has undertaken all pre-supply and post supply activities in India; Nortel India has neither the finance nor technology nor experience to install these networks and therefore their only installing equipment supplied by its principal and that too at each stage with the help of the assessee, and since Indian company did not have any expertise or installation, the same was provided/supervised by the assessee; the premises of Nortel India is used as a sales outlet of the assessee in India; the title of equipment does not pass outside India since the equipment is finally accepted by the customer when it passes the acceptance test; the supply contract does not end with the loading of the equipment on the ship but also includes number of activities which are carried out in the Indian Territory and the compensation/remuneration for that is also included in the consideration; the expat employees remained and rendered services for more than 30 days in a fiscal year; the expatriate employees of the 6 assessee are present in India for supervising the installation projects in India and the assessee has made a technology and technical information available to the Indian subsidiary and thus confirming that the Indian entity did not have the technology; and Nortel India is a dependent agent of the assessee.
9. Insofar as the determination of the attribution is concerned, CIT(A) observed that the entire risk and responsibilities with regard to installation and commissioning has been borne by the assessee through various agreements and even with respect to the activities carried out by its subsidiary in India, the risks remained with the assessee and the entire contract which is work contract including supply, and their activities are carried out in India. These activities include site preparation, survey equipment installation, commissioning, mobile phone interface with other operators, customization including software installation and acceptance testing etc these are the effective milestones on which the right to income accrues to the assessee as such the entire activity which results in a crore of income are carried out in India, accepted shipment. Further it will also found that the profit from manufacture of these equipment which is outside India gets accounted once the cost of purchase and manufacture is admitted to the global account of the assessee as such in respect of equipment only with respect to the shipping activity can be said to be earned outside India and therefore an attribution of 80% of the income of the activities of the PE in India was a reasonable estimate.
10. Having approved the existence of permanent establishment under various limbs of article 5 of the DTAA, and also the taxability of the income derived by the assessee on the sale of hardware with embedded software, Ld. CIT(A) directed 7 the AO to allow deduction for all expenses incurred in and outside India for determining the taxable income of the alleged NPA in India. In respect of the assessment year 2003-04 the authorities below taxed income from provision of training services as "fees for technical services" under the provisions of article 12 of the DTAA by allocating 5% of the total supply revenues towards provision of training services. Aggrieved by these findings, assessee preferred ITA members 2756 to 2760/Del/09.
11. In respect of the income from supply of equipment, Ld. AR argued that the equipments were manufactured overseas (raw materials, parts and components are also procured from overseas); equipment is supplied from overseas and title in the equipment is also transferred overseas; contracts for supply of equipment are concluded overseas; payments for such supplies are also received from overseas; all major risks and rewards vest with the assessee overseas; and all major functions such as development of advanced technology items, branding, marketing and global logistics are performed overseas. Hence, there is no source of income in India and consequently, no portion of the profits arising from equipment supply can be attributed to the assessee's activities in India.
12. It is the further argument of the learned AR that on similar facts similar questions arose for consideration of the Hon'ble jurisdictional High Court in the case of the Nortel networks India International Inc and the Hon'ble jurisdictional High Court dealt with all the aspects adverted to by the Ld. CIT(A) in this matter and the conclusions recorded by the Hon'ble jurisdictional High Court are applicable to the facts of this case also. Copy of the order dated 22/12/2009 in appeal No. 324 and 325/06-07 and 242/07-08 passed in the case of Nortel 8 Networks India International Inc is made available for appreciation before us for understanding the similarity of the issues involved in these cases. In the light of the submissions, for proper appreciation of this contention that the findings and the decision of the Hon'ble jurisdictional High Court in the case of Nortel Networks India International Inc vs Director of Income tax, 286 ITR 353, are applicable to the facts of this case also, we deem it just and proper to look at the facts involved in that case.
13. The facts in the case of Nortel Networks India International Inc are that the said company was incorporated in the USA and was a tax resident of USA. It was a part of Nortel Group which was stated to be a leading supplier of hardware and software for GSM Cellular Radio Telephone Systems. The assessee was a step- down subsidiary of 'Nortel Canada'. Nortel Canada also had an indirect subsidiary in India, namely, 'Nortel India'. Nortel Canada also had a Liaison Office in India called 'Nortel LO'.
13.1 Nortel India negotiated and entered into three contracts with 'Reliance', namely, Optical Equipment Contract ('the Equipment Contract'), Optical Services Contract ('the Services Contract') and the Software Contract ('the Software Contract'). On the same date, Nortel India entered into an agreement assigning all rights and obligations to sell, supply and deliver equipment under the Equipment Contract to the assessee. Reliance and Nortel Canada were also parties to the assignment contract and in terms thereof, Nortel Canada guaranteed the performance of the Equipment Contract by the assessee (Assignee). In terms of the assignment contract, Reliance placed purchase orders directly on the assessee and also made all payments for the equipments supplied directly to the assessee.
913.2. The equipments supplied to Reliance were manufactured by Nortel Canada. The same was invoiced by the assessee directly to Reliance and consideration for the same was also received directly by the assessee. It was asserted by the Assessing Officer that the equipment supplied to Reliance was sourced from Nortel Canada at a much higher price than the price charged to Reliance and this resulted in the assessee suffering a loss during the relevant period.
13.3. The Assessing Officer was of the view that the assessee had been incorporated solely with the motive to evade the taxes arising out of supply contract in India and in substance, the contracts were performed by Nortel Canada along with its LO and Nortel India, acted in unison to identify, negotiate, appraise, secure, execute, manufacture, supply, install, commission and provide warranty and after sales service in respect of the contract entered into with Reliance.
13.4. On the basis of its findings, the Assessing Officer concluded that Nortel India and Nortel LO constituted the assessee's PE in India (both Fixed Place PE as well as Dependent Agent PE).
13.5. He then proceeded to estimate the taxable income of the assessee based on the accounts of Nortel Group. The Assessing Officer noticed that the global accounts of the Nortel Group disclosed a gross profit margin of 42.6 %. He held that average selling, general and marketing expenses of other similarly placed non-resident companies was 5% of the turnover and, therefore, made an allowance of 5% of such expenses. He also made a further allowance for Head Office expenses at 5% of the adjusted profits and estimated the taxable income of the assessee.
1013.6. The Commissioner (Appeals) upheld the order of Assessing Officer that office of Nortel LO and Nortel India would constitute a fixed PE of the assessee in India as the assessee and Nortel Canada were one and the same entity, and in the process of reaching such a conclusion, Ld. CITA made the following observations:-
"that the assessee has permanent establishment and business connection in India in the form of Nortel Networks India private limited and the liaison office of parent Nortel Networks Ltd, Canada;
the employees of the assessee or other personnel carried out the business of the assessee through the premises of the LO or the premises of the subsidiary;
the assessee has undertaken all pre-supply and post supply activities in India;
Nortel India has neither the finance, nor technology nor experience to install these networks and therefore their only installing equipment supplied by its principal and that too at each stage with the help of the assessee, and since Indian company did not have any expertise for installation, the same was provided/supervised by the assessee;
the premises of Nortel India is used as a sales outlet of the assessee in India;
the title of equipment does not pass outside India since the equipment is finally accepted by the customer when it passes the acceptance test;
the supply contract does not end with the loading the equipment on the ship but also includes number of activities which are carried out in the Indian Territory and the compensation/remuneration for that is also included in the consideration;
the expat employees remained and rendered services for more than 30 days in a fiscal year;
the expatriate employees of the assessee are present in India for supervising the installation projects in India and the assessee has made a technology and technical information available to the Indian subsidiary 11 and thus confirming that the Indian entity did not have the technology; and
14. A careful reading of the order dated 22/12/2009 in Appeal No. 324 and 325/06-07 and 242/07-08 passed in the case of Nortel Networks India International Inc by the Ld. CIT (A), order dated 04/05/2016 of the Hon'ble jurisdictional High Court in ITA No. 666/2014 and batch in the case of M/s Nortel Networks India International Inc, (supra) and the impugned order in the case on hand as narrated in paragraph number 8, makes it amply clear that the facts are substantially the same, giving rise to the similar questions of fact and law.
15. Hon'ble High Court dealt with the findings of the Ld. CIT(A), which are on similar facts in both the cases, vide paragraph Nos. 69,74,63,67,71,70,47,59 and 73 in the case reported in 286 ITR 353, in the following way: -
16. On the aspect of the permanent establishment and business connection in India vide paragraph No. 69 Hon'ble jurisdictional High Court observed that,-
"69. The AO, CIT(A) and ITAT have held that the office of Nortel India and Nortel LO constituted a fixed place of business of the Assessee. As pointed out earlier, we find no material on record that would even remotely suggest that Nortel LO had acted on behalf of the Assessee or Nortel Canada in negotiating and concluding agreements on their behalf. Thus, it is not possible to accept that the offices of Nortel LO could be considered as a fixed place of business of the Assessee. In so far as Nortel India is concerned, there is also no evidence that the offices of Nortel India were at the disposal of the Assessee or Nortel Canada. Even if it is accepted that Nortel India had acted on behalf of the Assessee or Nortel Canada, it does not necessarily follow that the offices of Nortel India constituted a fixed place business PE of the Assessee or Nortel Canada. Nortel India is an independent company and a separate taxable entity under the Act. There is no material on record which would indicate that its office was used as an office by the Assessee or Nortel Canada. Even if it is accepted that certain 12 activities were carried on by Nortel India on behalf of the Assessee or Nortel Canada, unless the conditions of paragraph 5 of Article 7 of the Indo-US DTAA is satisfied, it cannot be held that Nortel India constituted a fixed place of business of the Assessee or Nortel Canada."
17. In respect of the allegation that the employees of the assessee or other personnel carried out the business of the assessee through the premises of LO or the premises of the subsidiary, vide paragraph No. 74 Hon'ble High Court held that,-
"74. The CIT(A) as well as the ITAT has proceeded on the basis that the Assessee had employed the services of Nortel India for fulfilling its obligations of installation, commissioning, after sales service and warranty services. The ITAT also concurred with the view that since employees of group companies had visited India in connection with the project, the business of the Assessee was carried out by those employees from the business premises of Nortel India and Nortel LO. In this regard, it is relevant to observe that a subsidiary company is an independent tax entity and its income is chargeable to tax in the state where it is resident. In the present case, the tax payable on activities carried out by Nortel India would have to be captured in the hands of Nortel India. Chapter X of the Act provides an exhaustive mechanism for determining the Arm's Length Price in case of related party transactions for ensuring that real income of an Indian Assessee is charged to tax under the Act. Thus, the income from installation, commissioning and testing activities as well as any function performed by expatriate employees of the group companies seconded to Nortel India would be subject to tax in the hands of Nortel India and the same cannot be considered as income of the Assessee."
18. On the aspect of the assessee undertaking the pre-supply and the post supply activities in India, it is relevant to refer to paragraph numbers 63 and 67 of the order of the Hon'ble High Court:
"63. Undisputedly, even if it is accepted that some portion of the obligations undertaken by the Assessee were performed in India, the Assessee's income arising from the performance of the Equipment Contract 13 could be brought to tax only to the extent as permissible under the relevant DTAA - DTAA between India and USA or DTAA between India and Canada.
xxx xxx xxx
xxx xxx xxx
67. Thus, if we proceed on the assumption that a part of the Assessee's income is attributable to activities carried out in India through a business connection, the question whether the Assessee had a PE in India during the relevant AYs would become relevant. This is so because, if the Assessee did not have any PE in India then its business income would not be taxable under the Act even though a part of the same can be attributed to activities in India."
19. While adverting to the finding of the authorities below that the Norton India has neither the finance, nor technology nor experience to install the networks, as such they are only installing equipment supplied by its principal and that too at each stage with the help of the assessee and further that since the Indian company did not have any expertise 5 installation, the same as provided/supervised by the assessee, the Hon'ble High Court held in paragraph No. 71 that,-
"71. The AO's conclusion that there is an installation PE in India, is also without any merit. A bare perusal of the Services Contract clearly indicates that the tasks of installation, commissioning and testing was contracted to Nortel India and Nortel India performed such tasks on its own behalf and not on behalf of the Assessee or Nortel Canada. Undisputedly, Nortel India was also received the agreed consideration for performance of the Services Contract directly by Reliance."
20. The High Court rejected the contention of the revenue that the premises of Nortel India was used as a sales outlet of the assessee in India, by observing in paragraph No. 70 that,-
14"70. The AO has further alleged that the offices of Nortel LO and Nortel India were used as a sales outlet. In our view, this finding is also unmerited as there is no material which would support this view. The facts on record only indicate that Nortel India negotiated contracts with Reliance. Even assuming that the contracts form a part of the single turnkey contract, which include supply of equipment - as held by the authorities below - the same cannot lead to the conclusion that Nortel India was acting as a sales outlet."
21. Insofar as the observations of the 1st appellate authority that the supply contract does not end with the loading the equipment on the ship but also includes number of activities which are carried out in the Indian Territory and the compensation/remuneration for that is also included in the consideration, is concerned, it is held vide paragraph No. 59 that,-
"59. It is apparent from the above that the Assessee only assumed the obligation to sell, supply and deliver equipment in terms of the Equipment Contract and was paid in terms of the pricing mechanism as agreed to under the Equipment Contract. It is also material to note that Nortel India continued to be responsible for performance of the Equipment Contract except for performance of Purchase Orders and Exchange Orders for supply of equipment which were placed directly by Reliance on the Assessee. Although, the Assessee had repeatedly asserted that all other obligations for testing, installation and commissioning was done by Nortel India, for which Nortel India had been paid separately, no material or evidence was gathered by the AO to contradict the same. There is no material to indicate that equipment for Test Bed Laboratory, which was to be supplied at no additional cost to Reliance had been procured by Nortel India at additional cost or that Nortel India was not remunerated for all the services rendered by it to Reliance. In terms of the Equipment Contract, adequate stock of spares was required to be maintained in India, however, there is no material to indicate that such stock was maintained in India by the Assessee or that such stock was maintained by Nortel India, not on its own behalf but on behalf of the Assessee, without being sufficiently remunerated. Thus, in absence of any such evidence or material, it is difficult for us to concur with the view that certain activities were 15 performed in India for which the consideration was received by the Assessee."
22. Ld. CIT(A) observed that expatriates employees of the assessee were present in India for supervising the installation projects in India and the assessee has made technology and technical information available to the Indian subsidiary as such confirming that the Indian entity did not have the technology. On the observations of the CIT(A) that the expat employees remain in India and rendered services for more than 30 days in a financial year, the Hon'ble High Court observed at paragraph No. 74 that,-
"74. The CIT(A) as well as the ITAT has proceeded on the basis that the Assessee had employed the services of Nortel India for fulfilling its obligations of installation, commissioning, after sales service and warranty services. The ITAT also concurred with the view that since employees of group companies had visited India in connection with the project, the business of the Assessee was carried out by those employees from the business premises of Nortel India and Nortel LO. In this regard, it is relevant to observe that a subsidiary company is an independent tax entity and its income is chargeable to tax in the state where it is resident. In the present case, the tax payable on activities carried out by Nortel India would have to be captured in the hands of Nortel India. Chapter X of the Act provides an exhaustive mechanism for determining the Arm's Length Price in case of related party transactions for ensuring that real income of an Indian Assessee is charged to tax under the Act. Thus, the income from installation, commissioning and testing activities as well as any function performed by expatriate employees of the group companies seconded to Nortel India would be subject to tax in the hands of Nortel India and the same cannot be considered as income of the Assessee."
23. The Hon'ble High Court considered the aspect whether or not the Nortel India is dependent on agent of the assessee vide paragraph No. 73 in the light of the facts involved in this case.
16"73. The AO has also held that Nortel India constituted Dependent Agent PE of the Assessee in India. The aforesaid conclusion was premised on the finding that Nortel India habitually concludes contracts on behalf of the Assessee and other Nortel Group Companies. In the present case, there is no material on record which would indicate that Nortel India habitually exercises authority to conclude contracts for the Assessee or Nortel Canada. In order to conclude that Nortel India constitutes a Dependent Agent PE, it would be necessary for the AO to notice at least a few instances where contracts had been concluded by Nortel India in India on behalf of other group entities. In absence of any such evidence, this view could not be sustained."
24. Insofar as the place of transfer of title in the equipment, whether it is within or without India, in the case of Nortel Networks India International Inc Hon'ble High Court observed that, there seems to be no dispute that the title to the equipment passed in favour of Reliance overseas. In the case on hand, it is the observation of the Ld. Commissioner that though in terms of agreement the ownership in respect of equipment was transferred outside, the assessee has been rendering services like customer technical assistant service and emergency technical assistant service on a 24-hour basis and 7 days a week basis, and the supply contract does not end with the loading of the equipment on the ship but includes a number of activities which are carried out in the Indian territory and the compensation/remuneration for that is also included in the consideration. On this premise Ld. CIT(A) concluded that the it is an arrangement between the assessee and the Indian entity according to which their risk and responsibility of both are conterminous.
25. In furtherance of this, Ld. DR submitted that the business of supply of goods involved the broad steps like generation of enquiries from the customers, obtaining license from Department of Telecom and various agencies, network 17 survey, pre-bid negotiations, presentation and clarifications, signing the contract, manufacture of hardware and software, actual supply, commissioning and testing, training of engineers of Indian customers in network management and after sales services which includes repair service, supply of spares without extra charges till warranty period, removing software bugs and supply of software updates without extra charges till warranty period. He submits that since most of the work in execution of the supply contract includes the steps taken on the Indian soil, it cannot be said that only when the product was finally accepted by the customer, the title in the equipment passed to the Indian customer and such part of contract took place on Indian soil and liable for tax.
26. As could be seen from the order of the Hon'ble jurisdictional High Court, this aspect of passing of title of the equipment, whether it is in India or outside India in the light of the fact that the equipment was finally accepted by the customer when it passes the acceptance test, was also considered and in paragraph No. 47 the Hon'ble High Court observed that, -
"47. As noticed earlier, there seems to be no dispute that the title to the equipment passed in favour of Reliance overseas. However, the AO, CIT (A) and ITAT did not consider the same to be relevant as according to them, the equipment continued to be in the possession of the "Nortel Group' till its final acceptance by Reliance. In our view, even if it is accepted that the equipment supplied overseas continued to be in possession of Nortel India till the final acceptance by Reliance, the same would not imply that the Assessee's income from supply of equipment could be taxed under the Act. Clause (a) of Explanation 1 to Section 9(1)(i) of the Act postulates the principle of apportionment and only such income that can be reasonably attributed to operations in India would be chargeable to tax under the Act. The position in Ishikawajima-Harima Heavy Industries (supra) was also similar. There too, the equipments were supplied overseas and the contractor continued to retain control of equipment and material till the 18 provisional acceptance of the work or the termination of the contract. The relevant clause which was considered by the Supreme Court in that case is as under:-
"22.1 Title to equipment and materials and contractor's equipment: Contractor agrees that title to all equipment and materials shall pass to the owner from the supplier or subcontractor pursuant to section E of exhibit H (General Project Requirements and Procedures). Contractor shall, however, retain case, custody, and control of such equipment and materials and exercise due care thereof until (a) provisional acceptance of the work, or (b) termination of this contract, whichever shall first occur. Such transfer of title shall in no way affect the owner's rights under any other provision of this contract."
27. Basing on the above findings, Hon'ble Jurisdictional High Court reached a conclusion that the income of the assessee from supply of equipment was not chargeable to tax in India and the question relating to the attribution of any part of such income to activities in India does not arise. It further held that the income from installation, commissioning and testing activities as well as any function performed by expatriate employees of the group companies seconded to Nortel India would be subject to tax in the hands of Nortel India and the same cannot be considered as income of the assessee therein.
28. In view of the similarity of the facts and questions of law involved in these two matters, we are of the considered opinion that the observations of the Hon'ble High Court in the case of M/s Nortel networks India International Inc (supra) are squarely applicable to the facts of this case also, and accordingly we find that the income of the assessee wherein from supply of equipment was not chargeable to tax in India and the question relating to the attribution of any part of such income to activities in India does not arise. Income from installation, 19 commissioning and testing activities as well as any function performed by expatriate employees of the group companies seconded to Nortel India would be subject to tax in the hands of Nortel India and the same cannot be considered as income of the assessee therein. In view of our finding, the question of attribution of any income to the alleged PE does not arise. Grounds No. 1 and 1.1 in all the appeals of the assessee are, accordingly, allowed.
29. Next coming to software issue, Assessee's contention that it has transferred the subject matter of a copyright, which tantamount to sale of a product, not covered within the scope of 'Royalty', while retaining with itself the copyright per se. The Assessing Officer has failed to appreciate the assessee's contention that transfer of the subject matter of a copyright is analogous to the rights acquired by the purchaser of a book. The purchaser of the book does not acquire the right to exploit the underlying copyright. When the purchaser reads the book, he only enjoys its contents. Similarly, the user of the copyrighted software i.e., the integral part of the telecommunication equipment, does not receive the right to exploit the copyright to the software he only enjoys the product in the normal course of his business since the software embedded in the telecommunication/ equipment is an operating program. The equipment cannot function without the program and the program cannot be used in other equipment. Thus, the software does not have any value of its own. The user is allowed to use the software only, when he uses the equipment. It is also well settled internationally that consideration for supply of operating software is in the nature of business income and cannot be subjected to tax as 'Royalty'.
30. Ld. CIT(A), while considering this issue, observed that the domestic 20 copyright Act is to be applied in this case in terms of paragraph No. 3(2) of the Indo-Singapore Double Taxation Avoidance Agreement (DTAA), which makes it mandatory to add after the definition of the word "copyright" as given in the law by the state applying the provisions of the treaty which in the instant case is the Copyright Act, 1957. He therefore proceeded to observe that the Indian copyright acts 1957 or any other circular of CBDT do not make any distinction between "Copyright Right" or "Copyrighted Article" and also that the Singapore Regulations cannot be extended to the Indian Territory as within the territory of sovereign the laws promulgated by the Indian sovereign shall apply. On this premise, CIT(A) distinguished the decisions of the Special Bench in the case of Motorola, (97 ITD 1) on the basis of facts and the case in Tata consultancy services delivered by the Hon'ble Apex court on the ground that such a decision was pronounced on the basis of the Sales- tax Act and not on the basis of the provisions of the income tax Act.
31. Be that as it may, an identically similar issue had arisen in the case of group company i.e., Nortel Networks India International Inc Vs. ADIT in ITA Nos. 3313 to 3315/Del/2012 wherein a coordinate bench of this Tribunal while placing reliance on the decision of the Hon'ble jurisdictional High Court in the case of CIT Vs. ZTE Corporation (2017) 392 ITR page 80 (Del.) held that, -
19. Now coming to the issue relating to taxation of Software is concerned, for Assessment Year 2006-07, the Assessing Officer had separately brought the receipts on account of sale of embedded software as royalty. Ld. AR contended that this issue also stands squarely covered in favour of the Assessee once it was held that the Assessee was not taxable under the provisions of Section 9 itself. Even otherwise, according to him, the issue of embedded software in hardware whether could be taxed separately as royalty already stands decided by the jurisdictional High Court in the case 21 of CIT Vs. ZTE Corporation (2017) 392 ITR page 80 (Del.). Ld. DR vehemently relied on the orders of the authorities below.
20. In CIT Vs. ZTE Corporation (2017) 392 ITR page 80 (Del.) it is held as follows:
"21. The reference to clauses (a) and (b) means that all the rights which are in literary works i.e. "(i) to reproduce the work in any material form including the storing of it in any medium by electronic means;(ii) to issue copies of the work to the public not being copies already in circulation;(iii) to perform the work in public, or communicate it to the public;(iv) to make any cinematograph film or sound recording in respect of the work;(v) to make any translation of the work;(vi) to make any adaptation of the work;(vii) to do, in relation to a translation or an adaptation of the work, any of the acts specified in relation to the work in sub-clauses (I) to (vi)"
inhere in the owner of copyright of a computer programme. Therefore, the copyright owner's rights are spelt out comprehensively by this provision. In the context of the facts of this case, the assessee is the copyright proprietor; it made available, through one time license fee, the software to its customers; this software without the hardware which was sold, is useless. Conversely the hardware sold by the assessee to its customers is also valueless and cannot be used without such software. This analysis is to show that what was conveyed to its customers by the assessee bears a close resemblance to goods- significantly enough, Section 14(1) talks of sale or rental of a "copy". The question of conveying or parting with copyright in the software itself would mean that the copyright proprietor has to assign it, divesting itself of the title implying that it has divested itself of all the rights under Section 14. This would mean an outright sale of the copyright or assignment, under Section 18 of the Act. Section 16 of the Copyright Act enacts that there cannot be any other kind of right termed as "copyright".
22. In the present case, the facts are closely similar to Ericson. The supplies made (of the software) enabled the use of the hardware sold. It was not disputed that without the software, hardware use was not possible. The mere fact that separate invoicing was done for purchase and other transactions did not imply that it was royalty payment. In such cases, the nomenclature (of license or some other fee) is indeterminate of the true nature. Nor is the circumstance that updates of the software are routinely given to the assessee's customers. These facts do not detract from the nature of the transaction, which was supply of software, in the nature of 22 articles or goods. This court is also not persuaded with the submission that the payments, if not royalty, amounted to payments for the use of machinery or equipment."
21. Having considered the submissions of the Ld. AR in the light of the orders of the authorities below and the above decision, we find ourselves in agreement with the submission made on behalf of the assessee that the embedded software is not royalty and the receipts on account of sale of embedded software cannot be separately brought to tax. "
32. It is not the case of the revenue that the software involved in this case is independent of the functioning of the hardware. Revenue does not dispute the fact that in this matter the hardware and software are interdependent in the sense that hardware is useless without this particular software and the software cannot be used in any hardware other than the one for which it is permitted to be used. Similar are the facts in the case of Networks India International Inc. Facts being similar, the above decision is applicable to the present case also. While respectfully following the same we hold that the payment for the embedded software is not royalty and the receipts on account of sale of embedded software cannot be separately brought to tax. Grounds No. 2 and 2.1 in all the appeals are, accordingly, allowed.
33. Now coming to ground No. 3 in appeal No. 2758/Del/2009 for the assessment year 2003-04, it relates to the taxing of income from providing training services as fees for technical services under the provisions of article 12 of the DTAA. Contention of the assessee is that the initial training services have to be performed only by the supplier of the equipment and are essential to facilitate the employees of GAIL operating telecom equipment, and therefore the same is undoubtedly ancillary and subsidiary as well as inextricably and essentially linked to the sale of the equipment and amounts only to supply of equipment 23 simplicitor. Assessee therefore contends that such payments cannot be taxed as if FTS in the hands of the assessee. In view of Article 12 (5) of the tax treaty, the term 'FTS' does not include amounts paid for services that are ancillary and subsidiary, as well as inextricably and essentially linked to the sale of property.
34. It is further contended that inasmuch as the contract between the assessee and GAIL is not a service contract and the assessee is not engaged in supervision of maintenance, the assessee services are restricted only to ancillary and subsidiary services and are inextricably and essentially linked to the sale of property.
35. Ld. DR submitted that the contract with GAIL clearly shows that the price for training has been separately quoted which is for training and handing over of the telecom system to the purchaser at each side, and as per article 12 of Indo Singapore Tax Treaty, this falls in the definition of FTS and it involves making available the technical knowledge as well as transfer of technical design. On this ground Ld. DR justified the orders of the authorities below.
36. Article 12(5)(a) is to the effect that notwithstanding paragraph 4, "fees for technical services" does not include payments for services that are ancillary and subsidiary, as well as inextricably and essentially linked, to the sale of property other than a sale described in paragraph 3(a) whereas payments in paragraph 3(a) refer to the payment of any kind received as a consideration for the use of, or the right to use any copyright of a literary, artistic or scientific work, including cinematograph film or films or tapes used for radio or television broadcasting, any patent, trade mark, design or model, plan, secret formula or process, or for 24 information concerning industrial, commercial or scientific experience, including gains derived from the alienation of any such right, property or information.
37. It is, therefore, clear that the payments for services that are ancillary and subsidiary, as well as inextricably and essentially linked to the sale of property other than a sale described in paragraph 3(a), cannot be treated as FTS. It cannot be said that in this matter what is sold by the assessee to the Indian telecom operators, more particularly to the GAIL includes the sale of any patent, trademark, design or model, plan, secret farmland or process so on and so forth. What is sold is the telecom equipment embedded with specific software to run that equipment; and for such purpose the assessee claims to have imparted some initial training because without which training the purchaser cannot operate the equipment and this training is only one time job for the use of equipment only. Admittedly, the contract between the assessee and the GAIL is not a service contract and the assessee is not entrusted with the job of any supervision or maintenance of the equipment so that for such continuous supervision or maintenance the requisite skills are made available to the employees of the GAIL. In terms of Article 12(5)(a) of the treaty, payment received by the assessee for the training required for the employees of the Gail at the time of delivery of the product to acquaint them with the operation of the equipment does not amount to FTS and cannot be brought to tax. We, therefore, allow ground No. 3 in ITA No. 2758/Del/2009.
38. Lastly, in respect of the R&D expenses, record reveals that subsequent to the order dated 27/02/2009 passed by the CITA, while giving effect to the said order, AO continued to take gross profit margins of Nortel Canada for computing 25 the total tax and interest liability. Challenging the same assessee preferred an appeal and by order dated 22/12/2009, CIT(A) directed that the adjusted net profit margins of Nortel Canada need to be applied while computing taxable income of the alleged PE of Nortel Singapore that is the expenses relatable to the PE made to be allowed in some proportion which expenses of Nortel Canada bear to its revenues. Pursuant to the above the assessee filed computations of its revised taxable income and tax liability claiming several deductions including the research and development expenses. According to the assessee they are engaged in supply of highly advanced network equipment as such the R&D expenses are prima facie included towards earning income from supply of telecom equipment and once an expense on account of supply of such network equipment is held by the CIT(A), it becomes imperative to allow deduction for such R&D expenses which are incurred for the purpose of earning income from supply of network equipment. However ld. AO did not allow the same, as such the assessee preferred Appeals No. 80 to 84/09-10. Ld. CITA by order dated 20/01/2011 allowed the appeal and directed the AO to allow R&D expenses to the assessee on proportionate basis. Challenging this direction revenue preferred Appeals Nos.2172 to 2176/Del/2011.
39. It is the argument of the Ld. DR that the research and development expenses are revenue in nature, as such no deduction could be allowed in respect of the same but the CIT(A) without giving an opportunity to the AO to verify such expenses, allowed deduction, as such, the impugned finding needs to be reversed.26
40. It is the argument of the Ld. AR that no reasons have been given by the ld AO as to why this expenses were not allowed while allowing the selling and administrative expenses.
41. In the remand report dated 08/11/2010, it is stated that the research and development expenses are available only if it is shown during the course of assessment; that such expenses are been incurred only ended exclusively for the purpose of the business and earning income that is being tax, and assessee had not taken any steps in this direction. Further it is stated by the Ld. AO that while giving affected to the appeal order is not open for him to start any new line of inquiry as to the allowability of any expense. You admitted that this expenses are not verified by him and if desired he will conduct such enquiry.
42. However, CIT(A) noticed that no reason for this allowance of R&D expenses was given either in the assessment order passed under section 143(3) or at the time of appeal effect orders; the assessee is engaged in the business of supply of highly advanced the telecom network equipment to telecom operators around the globe as such the R&D expenditure cannot be denied to be a business necessity for carrying out innovation and development of improved products to keep up with the changes in the technology; the R&D expenses appear in the same set of accounts of the assessee from which the sales figures of the equipment have been adopted and a GP rate has also been applied on the basis of the same accounts; and there are several cases of foreign, equipment manufacturers and suppliers including Nokia Corporation, being especially in the Department and in all such cases R&D expenses are being allowed and net profit ratio has been adopted from global accounts of the assessee for the purpose of 27 attribution of profits which means R&D expenses have been allowed in that case on the basis of the global accounts.
43. We do not see any illegality or irregularity in the impugned orders of the Ld. CITA. Be that as it may, in grounds No 1, 1.1, 2, and 2.1 in all the appeals of the assessee, it is found that income from the supply of equipment is not taxable in India. In the circumstances we do not find any merit in the contention of the revenue and accordingly dismiss the grounds of these appeals.
44. In view of our conclusion that the Assessee's income from supply of equipment was not chargeable to tax in India, the receipts on account of sale of embedded software cannot be separately brought to tax and that the income from providing training services cannot be treated as fees for technical services under the provisions of Article 12(5)(a) of the DTAA, the question relating to attribution of any part of such income to activities in India does not arise. In view of our conclusion that the Assessee does not have a PE in India, the question of attribution of any income to the alleged PE also does not arise.
45. In the result, whereas appeals of assessee are allowed, and the appeals of the revenue are dismissed.
Order pronounced in the open court on this the 24th day of April, 2018.
Sd/- Sd/-
(G.D. AGRAWAL) (K. NARASIMHA CHARY)
PRESIDENT JUDICIAL MEMBER
Dated: April, 2018
'VJ'
28
Copy forwarded to:
1. Appellant
2. Respondent
3. CIT
4. CIT(A)
5. DR, ITAT
By order
Asstt. Registrar