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(a) As mentioned earlier, computer hardware and software have been supplied separately.

(b) The import has not been made under any approved schemes.

5. It was contended that the assessee is a manufacturer and supplier of electronic switching systems required in the telecommunication industry and the switching system manufactured and supplied to the customers is based on customer specific requirement and depending upon such requirement of each customer's order, switch has to be configured and the software is integrated with the switch. The assessee, for this purpose, imports software as well as parts and components of the switching system. The assessee integrates software into hardware and sells switch to the DOT and it was claimed that as it was integrated transaction, there was no obligation to deduct tax at source. The contention of the assessee was rejected by the ITO (TDS) on the ground that import of software may be regarded as patent or invention or as a scientific work or a secret formula or process and accordingly the payments made for acquisition of the same would be a royalty as defined in the Explanation to Section 9(1)(vi) of the Act. He has also taken the view that the amount paid could be regarded as royalty within the meaning of the expression in Article 12(3)(a) of the DTAA entered into between India and the United States as the definition of royalty in the DTAA is similar to the definition in the Explanation to Section 9(1)(vi) of the Act. According to him, the software is not sold outright as the intellectual property rights continue to belong to Lucent. However, as the software is an integral part of the equipment supplied, the consideration paid would also be regarded as consideration for the use of or the right to use industrial, commercial or scientific equipment and would accordingly be royalty within the meaning of Article 12(3)(b). In corning to this conclusion, the AO has also relied upon the decision of the Authority for Advance Ruling in ABC, In re (1999) 238 ITR 296 (AAR). The relevant findings of the AO recorded in para. 2 of his order are extracted for the purpose of completion :

7. The learned counsel for the assessee reiterated the facts and contentions that were taken before the two authorities. The learned counsel pointed out that the DOT places purchase order for supply of a digital local telephone exchange on the assessee. The price for the equipment to be supplied is a lump sum price and the equipment to be supplied consists of various modules as well as the software that runs the equipment. The learned counsel drew our attention to purchase order, which is placed at pp. 1 to 13 of the compilation. The learned counsel elaborately dealt with the facts relating to equipment to be supplied for Vanasthalipuram exchange. On the basis of the order it received from the DOT, it places its own order on Lucent, USA, for supply of the parts and components of the switching system. The said purchase order is placed at pp. 14 to 16 of the paper book. The learned counsel stressed that the perusal thereof would reveal that a single purchase order for lumpsum consideration of USD 1,29,804.56 is placed on Lucent, USA. The annexure to the orders sets out the various items that are to be supplied by Lucent, USA. It is clear from the aforesaid that Lucent, USA, has also to supply the applicant software required to make the equipment operational. Lucent, USA, in turn, raises two invoices for the supply of the various items of hardware as well as the software. It is clear from the respective invoices, which are placed at pp. 17 and 18A of the paper book, that such supplies are made pursuant to a single purchase order. It was explained that upto July 1998, customs duty was payable on the software supplied as can be seen from p. 19 of the paper book. It is only thereafter that owing to exemption notification, excise duty was not paid for the software supplied. The assessee, thereafter integrates the software into hardware and sells the switch to the DOT. Copy of the invoice raised by the assessee on the DOT is placed at p. 20 of the paper book.

7(i) The learned counsel pointed out that acquisition of software component is, therefore, inextricably linked to the acquisition of hardware. None of its units can function independently. The learned counsel pointed out that considering, these facts, there was absolutely no obligation on the part of the assessee to deduct tax at source. The learned counsel explained that so far as the supply of hardware component is concerned, there could be no question of any royalty embedded therein and the provisions of Section 9(1)(vi) do not apply to the facts of the case. It was pointed out that the assessee is not supposed to use software item, which the assessee is required to integrate into the hardware, in any other transaction of activity. The learned counsel pointed out that the entire software is customer-made i.e., to the requirement of a particular buyer. The question of its being used in any other equipment is simply out of place. Even the equipment that is imported for one particular exchange cannot be used in any other exchange. The learned counsel further pointed out that the assessee cannot even duplicate the software for any subsequent use. The ITO (TDS), the learned counsel pointed out, is not justified in treating the acquisition of software that is supplied as patent or invention or a scientific work or a secret formula or process and also erred in treating the payment made for acquisition of the same as in the nature of royalty within the meaning of Section 9(1)(vi) of the Act. The learned counsel pointed out that the software that is supplied in the facts of the case is an integral part of the equipment supplied and the consideration paid for such acquisition is not consideration for the use of or the right to use any industrial, commercial or scientific equipment within the meaning of Article 12(3)(b) of the DTAA entered into between India and US. The learned counsel pointed out that the transaction between the assessee and Lucent, USA, is a transaction for purchase of switching system including parts and components thereof. The software that is purchased is an integral part of the switching system and there is no dispute that the payment made by the assessee for purchase of hardware is not exigible to tax in India inasmuch as the transfer of hardware took place outside India. On a parity of reasoning, as the transfer of the software has also taken place outside India there can be no accrual in respect of the same in India. The learned counsel went on to make a distinction between 'copyrighted article' and 'copyright' rights. The learned counsel illustrated it in the form of purchase of book or a music cassette. In a transaction like this, what is purchased is a copyrighted article, the copyright belonging to the author or the singer as the case may be. The purchaser has no right whatsoever to duplicate or make copies of the work that is purchased. This distinction was again demonstrated with an example viz., if an Indian publisher imports several copies of a book for the purpose of sale in India it would amount to the purchase of a copyrighted article. But if publisher acquires a right to publish in the book in India and thereafter makes copies for the purpose of sale the payment made for acquiring the right would be regarded as a royalty. In the present case, the learned counsel pointed out, all that the assessee has acquired is certain software, which is to be integrated into the hardware that is purchased and thereafter to sell the equipment as a whole. The assessee has no right to duplicate or utilize the software purchased in any other switch that it may sell. It is not disputed that for each switching system sold by the assessee, a corresponding acquisition both of the hardware as well as the software is made from Lucent, USA. The learned counsel pointed out that a certificate issued by the Lucent, USA, wherein it has been clarified that the assessee had no legal authority to duplicate or the software either for the purpose of distribution or resale. A copy of the certificate is kept in the paper book. The distinction between the purchase of a copyrighted article and copyright rights is borne out by the preamble. The learned counsel went on to impress that the distinction between 'copyrighted article' and 'copyright rights' is borne out by the preamble and final regulations and classification of transaction involving computer programs published by the Internal Revenue Service of the Government of the United States. The said document is also placed in the paper book. It was pointed out that a transaction involving the transfer of computer program is treated as either being a transfer of a copyright article in the computer program or a transfer of a copy of the computer program (copyrighted article). It is therefore, clarified that a transfer of a computer program is classified as a transfer of a copyright if, as a result of the transaction, a person acquires either a right to make copies of the computer program for purpose of distribution to public, or the right to prepare a derivative computer program based on the copyrighted computer program or the right to publicly display the computer program. If, on the other hand, a person acquires a copy of the computer program but does not acquire any of the rights referred to hereinbefore, then, the transaction has to be classified as a transfer of a copyrighted article. It was submitted that on the basis of the distinction drawn, it would be clear that what the assessee has acquired is a copyrighted article and accordingly the consideration that is paid thereof has to be regarded as a purchase price and not a payment by way of royalty.

10. We have carefully considered the rival submissions and gone through the records in the light of the paper book filed by the parties as also the principles laid down by the judicial authorities to which our attention was drawn, at the time of hearing by both the parties, The facts of the case clearly reveal that the assessee is engaged in the manufacture and sale of electronic switching systems required for the telecommunication industry and a substantial part of its sales are to the DOT. As the facts reveal, initially DOT places a purchase order for supply of digital local telephone exchange equipment on the assessee. The price for the equipment to be supplied, is a lump sum price and the equipment to be supplied consists of various modules as well as the software that runs the equipment. The price of the equipment to be supplied for the Vanasthalipuram Exchange is Rs. 6,84,94,690. The cost of the switching equipment is Rs. 5,04,49,736. The break up of this sum is to be found at pp. 5 to 7 of the paper book. The cost of the software component embedded therein is Rs. 50,78,876 as is clear from p. 8 of the compilation. On the basis of the order so received from the DOT, assessee placed an order on Lucent, USA for supply of parts and components of the switching system. Purchase order placed for Vanasthalipuram Exchange is at pp. 14 to 16 of the paper book. A perusal thereof would clearly reveal that a single purchase order for a lump sum consideration of USD 1,29,804.56 is placed on Lucent, USA. The annexure to the orders sets out the various items that are to be supplied by Lucent, USA and it is clear therefrom that the application software has also to be supplied by Lucent, USA. Lucent, USA, in turn, raised two invoices, one for supply of various items of hardware and the other for supply of software. However, as is clear from pp. 17 and 18A, which are respective invoices that such supplies are .made pursuant to a single purchase order. The transaction, viewed from this angle, clearly shows that what the assessee has purchased is an integrated equipment both of hardware and software from Lucent, USA. In other words, the acquisition of software was inextricably linked to the acquisition of hardware and one cannot function without the other. It is impracticable to have such value addition without the help of the other. In our view, the assessee's transaction with Lucent, USA is a purchase of an integrated equipment, which consists of both hardware as well as software. One cannot function without the help of the other. As pointed out by the learned counsel, what the assessee has purchased is a copyrighted article and not copyright of the rights. Therefore, it is wrong on the part of the Department to have separated the transaction of purchase of software and viewing the purchase of software as an independent transaction. The assessee had not acquired any rights in the software. The assessee cannot be seen to be duplicating the software in making use of the same. The software that is so supplied by Lucent, USA is customer-specific and cannot be even reused or duplicated in any other exchange where identical orders are placed by the DOT. In other words, software that is supplied by Lucent, USA is customer-specific and is required only to be integrated into hardware that is supplied for specific unit. The Department, therefore, in our view is not justified in bifurcating the transactions as one of supply of hardware and the other of software and treating software as a part of royalty. It must be appreciated that the assessee, in this case, has not acquired rights in the copyright program so that it can be exploited commercially. It is a customer-specific supply and it is a case of clear business transaction of purchase of equipment along with software to make the hardware functional. In our view, therefore, Department is not justified in treating the impugned payments as royalty simpliciter and thereby holding that the assessee is an assessee-in-default for failure to deduct tax at source, In our considered view, the facts of the case as already explained in earlier paragraphs and discussions herein, the payment for impugned transactions does not partake the character of royalty and, therefore, there is no question of any obligation on the part of the assessee to deduct tax at source in respect of these disputed payments. The assessee is under no obligation to deduct tax at source under Section 195 of the Act in respect of the sums paid for acquiring software. Therefore, the orders of the ITO (TDS) under Sections 201 and 201(1A) of the Act are therefore vacated.