While the order, passed on October 28, is significant in terms of the liability to withhold tax from payments made while importing software, the Delhi Income-Tax Appellate Order (ITAT) attracted the attention of tax professionals on account of its observation that questioned the sanctity of tax treaties.
In the order, which may spark multiple litigations, the division bench of ITAT observed that it is not necessary that provisions of tax treaties always override the provisions of domestic tax laws. In a situation, where a provision in the domestic tax law is incorporated after the signing of a Double Taxation Avoidance Agreement (DTAA), it is the domestic law that will override DTAA. According to the existing position, if there is a conflict between domestic tax laws and treaty provisions, the latter is supreme.
This is the first time that a judicial body or quasi judicial body has observed that domestic law can override treaty provisions. This observation was made while holding that royalty is payable by Microsoft. The ITAT has for the first time challenged the superiority of DTAAs India has signed with many countries.
The order says, “Assuming there was a conflict between the Act and the DTAA, the proposition that DTAA will prevail over the Act is not infallible. Later domestic tax legislation can override treaty provisions if there is an irreconcilable conflict (Gramophone India case).”
While the judgement assumes importance because of its offbeat approach on the sanctity of tax treaties, the order has a direct bearing on the software industry in India which now has to pay tax on all imports of software, irrespective of whether the purchase is a copyright or not. Currently, there are some judgements in favour of the assessee, if the software is a single user licence for use by oneself. In such cases, the licence was tantamount to a copyrighted product and, hence, should not suffer withholding tax because there is no exploitation of copyright in the licence. The Delhi ITAT order changes this.
Vispi Patel of Vispi T Patel & Associates said,”The Delhi bench has quoted Supreme Court order in the case of Gramophone India. The contexts in both the cases are different and, therefore, it is not right in applying the same yardstick in the case of Microsoft.”
“The order is a significant departure from how payments for purchase of off-the-shelf software have been viewed by the appellate authorities earlier. It holds that such payments would be for use of a copyright (and not for use of copyrighted article) and would be taxable on a gross basis. The far reaching implications of this proposition apart, the judgement speaks of a treaty override by a subsequent domestic legislation if there is an ‘irreconcilable conflict’.
Delhi ITAT order questions the sanctity of tax treaties
Tribunal rules that provisions of tax treaties need not always over ride domestic tax laws
Against current practices, if a domestic tax law is incorporated in a DTAA, the former will override the latter
Software industry will have to pay tax on all software imports, whether the purchase is a copyright or not