<div>The Delhi High Court recently rendered a decision in the case of Nokia Networks OY (Nokia) on the issue of taxability of software embedded in GSM equipment (‘bundled software’) sold to Indian telecom operators. In simple words, bundled software means software loaded on a hardware or transferred as a component of hardware for a composite price.<br /><br />To provide a brief backdrop to this case, we may cast a quick glance at the provisions of the Income-tax Act, 1961 pertaining to taxation of royalty income which deals with the issue of taxation of software. As per the Act, royalty includes consideration received for transfer of rights in respect of any copyright, literary, artistic or scientific work. The definition of royalty does not explicitly include ‘use of computer software’. As the provision is silent on this issue, it gave rise to endless litigation on whether use of computer software would be tantamount to use of copyright and therefore be taxed as royalty income.<br /><br />To put an end to this debate, the Finance Act 2012 expanded the scope of the definition of royalty under the Act to include the use of any right in a computer software.<br /><br />Undoubtedly, this amendment has created major concerns for computer software providers and providers of equipments that include embedded software as they may now be required to pay taxes on the income earned from providing computer software in India.<br /><br />However, the amendment brought about by the Finance Act 2012 needs to be viewed in the context of tax treaties that India has entered into with several countries. This is significant in case of cross-border transactions, including use of computer software.<br /><br />Under the Act, a taxpayer can opt to be governed by the provisions of the Act or the relevant tax treaty, whichever is more beneficial to him. It is interesting to observe that in India’s tax treaties with countries such as USA, UK, Finland etc. it has adopted the pre-amendment royalty definition as per the Act (i.e. not including computer software), whereas it has included ‘use of computer software’ in the definition of ‘royalty’in tax treaties with certain countries viz. Malaysia, Morocco, etc.<br /><br />The Delhi High Court decision deals with this interplay between the provisions of the Act and the tax treaty on the issue of whether consideration for use of computer software is royalty or not.<br /><br />Nokia, a tax resident of Finland is a leading manufacturer of GSM equipment. During the relevant years, Nokia had a Liaison Office (“LO”) and also a 100% subsidiary in India known as Nokia India Private Limited ("NIPL"). Nokia sold GSM equipment manufactured in Finland to Indian telecom operators outside India on a principal-to-principal basis. Installation activities were undertaken by NIPL under its independent contracts with Indian telecom operators. The LO carried out advertising activities for Nokia.<br /><br />The main issue before the Court was whether consideration for supply of software embedded in theGSM equipment supplied by Nokia can be taxed as royalty in view of the amended provisions of the Act and the India-Finland tax treaty.It may be pertinent to note that although the amended definition of royalty under the Act includes use of computer software, the India-Finland tax treaty does not include ‘use of computer software’ in the definition of royalty.<br /><br />The Court relied on its earlier decision on a similar issue in the case of Ericsson A.B. and held that the payment received by Nokia towards supply of GSM equipment which contained embedded software was consideration received for supply of goods and not royalty income. The supply contract cannot be bifurcated into supply of hardware and software as the software merely facilitates the functioning of the equipment. The Court also remarked that a distinction has to be made between use of a ‘copyright’ and a ‘copyrighted article’. Finally, the Courtmade an important observation that the amendment in the royalty definition under the Act cannot be read into the treaty.<br /><br />Another noteworthy aspect of this judgment is that the Court struck down the attempt of the tax authorities to treat Nokia’s contract for offshore supply of equipments and NIPL’s installation contract as a composite contract. It held that when the property in the GSM equipment was transferred outside India it was not taxable in India and standalone agreements cannot be treated as composite agreements.<br /><br />Finally the Court ruled that Nokia did not have any tax presence in India by maintaining a liaison office for advertising activities in India.<br /><br />The most noteworthy aspect of the Delhi High Court’s decision is the observation that the retrospective amendment in the royalty definition may not impact the taxpayers so long as the definition of royalty in the tax treaty remains unchanged. A similar view was taken in a recent Mumbai Tribunal judgment in the case of B4U International Holdings Limitedin the context of transponder hiring charges.<br /><br />In a lighter vein, the never-ending litigation on the issue of taxability of software income in India may soon prove beyond doubt that taxing software is more taxing than creating software itself !!<br /><br /><br />(<em>Anita Nair is Deputy Manager, Deloitte Haskins & Sells</em>)<br /> </div>
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