Delhi High Court: ITO Ought to refer Terms of Distributor Agreement to Ascertain the Nature of Right Conferred on Distributor Partner/ Reseller

Delhi High Court: ITO Ought to refer Terms of Distributor Agreement to Ascertain the Nature of Right Conferred on Distributor Partner/ Reseller

The Delhi High Court by its division bench of Justices Rajiv Shakdher and Tara Vitasta Ganju while setting aside the Income Tax Department’s order rejecting the assessee’s application seeking a certificate for ‘NIL’ rate of withholding tax under Section 197 of the Income Tax Act, 1961, asserted that the concerned officer ought to have looked at the terms of Distributor Agreement, to ascertain as to what is the nature of right which is conferred on the distributor partner and/or the reseller.

A writ petition was filed by the petitioner- Milestone Systems A/S seeking to direct the against the lower withholding tax certificate dated 03.12.2021 and an undated order.

The record showed, that the petitioner had filed an application under Section 197 of the Income Tax Act, 1961 [in short, ‘the Act’] for being granted lower withholding tax certificate. The petitioner had sought a certificate, at ‘NIL’ rate of tax. The impugned certificate, however, pegged the rate of tax at 9.99% and the petitioner’s prayer was rejected.

The petitioner is a non-resident company, incorporated under the laws of Denmark. The petitioner, admittedly, has been issued a tax residency certificate by the concerned authorities in Denmark.

It was the petitioner’s case, that it is in the business of providing IP Video Management Software [hereafter referred to as ‘Software’] and other video surveillance related products to entities and persons across the globe. Insofar as India is concerned, the petitioner claimed, that it had entered into a Distributor Partner Agreement [hereafter referred to as ‘Distributor Agreement’] with various companies/entities for sale of its Software.

According to the petitioner, the Distributor Agreement did not confer any right of use of copyright on its partners or the end user. The petitioner claimed, that all that the distributor partner acquires under the Distributor Agreement is a license to the copyrighted Software.

It was therefore, the petitioner’s case, that this aspect of the matter has been considered in great detail by the Supreme Court in the judgment rendered in Engineering Analysis Center of Excellence Pvt. Ltd. vs. Commissioner of Income Tax and another (2021).

Mr Shashwat Bajpai, who appeared on behalf of the petitioner, stated that the concerned officer, in passing the impugned order dated 19.05.2021, had side stepped a vital issue i.e., whether or not the consideration received by the petitioner against the sale of software constituted royalty within the meaning of Section 9(1)(vi) and/or Article 13(3) of the Double Taxation Avoidance Agreement (DTAA) entered into between India and Denmark.

Mr Sanjay Kumar, senior standing counsel, who appeared on behalf of the respondent/revenue, that, while examining an application preferred under Section 197 of the Act, the concerned officer is not carrying out an assessment, and therefore, the parameters which apply for assessing taxable income would not get triggered, while rendering a decision qua an application filed under the aforementioned provision.

It was also Mr. Kumar’s contention, that under the provisions of Section 195, deduction of withholding tax is the rule, and issuance of a lower withholding tax certificate under Section 197 of the Act is an exception, therefore, that the rate of withholding tax indicated in the impugned certificate ought to be sustained.

The High Court at the very outset remarked that the, impugned order does not deal with the core issue which arose for consideration, and was the basis on which the application had been preferred by the petitioner under Section 197 of the Act.

The bench noted that it was the petitioner’s case, that the Software sold by it to its distributor partners under the Distributor Agreement did not confer, either on the distributor partner or the reseller, the right to make use of the original copyright which vested in the petitioner.

In this regard, the petitioner had relied on the decision passed by the Supreme Court in Engineering Analysis Center of Excellence Pvt. Ltd. vs. Commissioner of Income Tax and Another (2021), wherein inter alia, the Court has ruled, that consideration received on sale of copyrighted material cannot be equated with the consideration received for right to use original copyright work.

“Therefore, in our opinion, this central issue had to be dealt with by the concerned officer. Instead, as is evident on a perusal of paragraph 4 of the impugned order, the concerned officer has simply by-passed the aforementioned judgement of the Supreme Court by observing that the revenue has preferred a review petition, and that the same is pending adjudication”, stated the bench.

The Court was of the view that the concerned officer ought to have broadly, looked at the terms of Distributor Agreement, to ascertain as to what is the nature of right which is conferred on the distributor partner and/or the reseller.

The concerned officer had, instead, picked up one of the remitters i.e., the distributor partners, and made observations, which to say the least, do not meet the parameters set forth in Rule 28AA of the Income Tax Rules, 1962 [in short, “the Rules”] for estimating the income, that the petitioner may have earned in the given FY.

The bench opined that, “reduction of withholding tax under Section 195 is the rule, it is required to be borne in mind, that deduction of withholding tax morphs into an obligation, only if the sum received is chargeable to tax.”

The Court thus, set aside the order which rejected the petitioner’s application seeking a certificate for “NIL” rate of withholding tax as well as the which provided a withholding tax rate of 9.99%. The Court directed the concerned income tax officer to reconsider petitioner’s application under Section 197 afresh.

The Court emphasized that the concerned officer will apply his mind, inter alia, to the terms of the Distributor Agreement, and the ratio of the judgment rendered by the Supreme Court in Engineering Analysis. In this context, the provisions of Rule 28AA shall also be kept in mind,

The Court vociferously asserted that concerned officer shall not be burdened by the fact that a review petition is pending, in respect of the judgment rendered by the Supreme Court in Engineering Analysis.