Monday, June 27, 2011

ITAT (DEL) : -Software embedded in off-shore supply may be taxable even if supply not taxable

Raytheon Company vs. DDIT (ITAT Delhi)

Software embedded in off-shore supply may be taxable even if supply not taxable

The assessee, a USA company, entered into two separate contracts with AAI, one for supply of equipment and the other for rendering installation and training services. The AO & CIT(A) held (i) that the two contracts were an "indivisible works contract", (ii) that as the supply involved embedded software, the income had to be bifurcated between "supply of equipment" and "royalty" in the ratio of 30:70, (iii) that the equipment-supply profits had accrued on completion of contract and not at the time of transfer of title, (iv) that 50% of the equipment-supply profits was attributable to the assessee's PE in India and this was taxable at the global profit rate of 13.4%. On appeal to the Tribunal, HELD:

(i) The two contracts constitute one agreement because (a) the essential purpose of both contracts was to set up the ATS, (b) the contract for supply of equipment and software would have been of no consequence without installation and performance services, (c) the dates of payment for the supply contract were connected with the service contract and (d) it was difficult to segregate the contract from installation/service contract (Ishikawajima-Harima 288 ITR 408 (SC) referred);

(ii) The PE came into existence on clearance of the goods in India because after transfer of title outside India, the possession was handed over to the assessee for safe custody, installation etc. This required storage space and supervision which cannot be said to be preliminary or auxiliary activities in nature as the equipments were required to be installed;

(iii) The bifurcation of revenue into supply of equipment and software in the ratio of 30:70 had to be upheld because (a) though the software was embedded in the equipment and supplied as one package for one price, it was permissible to segregate the composite consideration into different components and (b) the assessee had not shown the segregation done by the customs authorities for imposing duty on the equipment and software (Rotem Company 279 ITR 165 (AAR) & Motorola 95 ITD 269 (SB) referred);

(iv) In a turnkey contract, in which the assessee is under obligation to supply the equipment and the software and also install them, the profit is taxable on completion of each milestone and not at the time of handing over the functioning system to the contracting party. The department's argument that in a works contract, mere supply of equipment and software is of no consequence till installation and so profits should be taxed at that stage is not correct because even if "turnkey", the taxable events in the execution of a contract may arise in several stages in several years if the obligations under the contract are distinct ones. The supply profits are consequently not taxable as it accrued on supply outside India;

(v) On facts, as the supply of equipment and software constituted a milestone in the contract, the income therefrom arose in the year of shipment which was in an earlier year. It did not accrue or arise in the present year. As the PE came into existence when the equipment was handed over to it by the AAI, the profits from installation contract and services was taxable.

Note: In Motorola Inc vs. DCIT 95 ITD 269 (Del)(SB) it was held that supply of embedded software in equipment was not taxable as "royalty" on the ground that the users had acquired a "copyrighted article" and not a "copyright". See Also DIT vs. LG Cable Ltd 237 CTR 438 (Del)

Related Judgements
1.DIT vs. LG Cable Ltd (Delhi High Court) Though the two contracts were entered into on the same day and between the same parties, the department's argument that they should be viewed as a composite contract is not sustainable because even assuming they should be read as one turnkey contract, offshore supplies are not taxable in India…

2.L. G. Cable Ltd vs. DDIT (6.2 MB) (ITAT Delhi) Where the assessee, a Korean company, had entered into two contracts, one for on-shore execution of a fiber optic system and the other for offshore supply and services and it had a project office in India and the question arose whether any part of the profits from offshore supply…

3.Airports Authority vs. DIT (AAR) Where the applicant entered into a contract with Raytehon USA for the acquisition of hardware and customized software and the title to the hardware was to pass outside India and all activities under the contract (except for installation and support activities) were to be performed by Raytheon outside India,…

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