ITO Can’t By-Pass SC Decision In ‘Engineering Analysis’ In The Name Of A Review Petition Filed By Dept: Delhi High Court

The bench of Justices Rajiv Shakdher and Tara Vitasta Ganju observed that the concerned officer had failed to consider the Apex Court’s decision in Engineering Analysis Centre of Excellence Pvt. Ltd. vs. Commissioner of Income Tax (2021), which was relied upon by the assessee in support of its plea for a “NIL” rate of withholding tax.

The assessee, in its application, had pleaded that the consideration received by it did not constitute royalty, and thus the same was not chargeable to tax, in view of the judgment of the Supreme Court in Engineering Analysis. However, the concerned officer had simply by-passed the said judgement of the Supreme Court on the ground that the revenue department has filed a review petition, the Court noted.

The bench remarked that as long as the judgment of the Supreme Court in Engineering Analysis (2021) is in force, the income tax authority cannot side step the judgment on the ground that the department has filed a review petition.

The Court thus directed the Income Tax officer to reconsider assessee’s application under Section 197, in light of the Supreme Court’s decision in Engineering Analysis (2021), where it was ruled that payments made to non-resident computer software manufacturers/ suppliers for resale/use of computer software, is not taxable as Royalty in India.

The petitioner, Milestone Systems A/S, is a non-resident company, incorporated under the laws of Denmark, and is in the business of providing IP Video Management Software and other video surveillance related products across the globe.

The petitioner entered into a Distributor Partner Agreement with various companies/entities for sale of its Software in India. Claiming that the sum it received under the Distributor Agreement was not chargeable to tax in India, the petitioner filed an application under Section 197 of the Income Tax Act for being issued a certificate with “NIL” rate of withholding tax.

The income tax authority, however, passed an order rejecting petitioner’s application seeking a certificate for “NIL” rate of withholding tax, and issued a certificate providing a withholding tax rate of 9.99%. Against the said withholding tax certificate issued to it, the petitioner filed a writ petition before the Delhi High Court.

The petitioner, Milestone Systems, argued before the Court that its partners or the end users are not conferred any ‘right of use of copyright’ under the Distributor Agreement. It claimed that the distributing partners only acquire a license to the copyrighted Software under the Agreement. It further pleaded that the said aspect has been dealt with by the Supreme Court in Engineering Analysis (2021), and thus the consideration received by it under the Distributor Agreement did not constitute royalty, and the same was not chargeable to tax.

The petitioner averred that the Income Tax officer, while passing the said order, had failed to consider the vital issue, i.e., whether or not the consideration received by it towards the sale of software in India, constituted royalty under the Income Tax Act and/or under the Double Taxation Avoidance Agreement (DTAA) between India and Denmark.

To this, the revenue department argued before the Court that while examining an application moved under Section 197, the concerned officer is not carrying out an assessment, and therefore, while rendering a decision on the Section 197 application, the parameters which apply for assessing taxable income would not get triggered.

As per Section 197 of the Income Tax Act, if the Assessing Officer (AO) is satisfied that the total income of the recipient justifies deduction of income tax at any lower rate or no deduction of income tax, the AO shall, on an application made by the assessee in this behalf, issue to him such lower withholding tax certificate, as may be appropriate.

Referring to the facts of the case, the Court concluded that the order rejecting the petitioner’s application seeking a certificate for “NIL” rate of withholding tax, did not deal with the core issue which arose for consideration, and which was the basis on which the application under Section 197 had been moved by the petitioner. The Court reckoned that the petitioner had relied upon the Apex Court’s decision in Engineering Analysis (2021) in support of its contention that the consideration received by it under the Distributor Agreement did not constitute royalty, and thus the same was not chargeable to tax. However, the same was not considered or dealt with by the concerned officer while passing the order, the Court said.

“As noted hereinabove, it is the petitioner’s case, that the Software sold by it to its distributor partners under the Distributor Agreement does not confer, either on the distributor partner or the reseller, the right to make use of the original copyright which vests in the petitioner. This plea was sought to be supported by the petitioner, by relying upon the judgment of the Supreme Court in Engineering Analysis, 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,” the Court said.

The bench held that as long as the judgment of the Supreme Court in Engineering Analysis (2021) is in force, the concerned income tax authority could not have side stepped the judgment on the ground that the revenue department has filed a review petition against the said judgment.

The Court added that the concerned officer was required to examine the Section 197 application in the background of the parameters set forth in Rule 28AA of the Income Tax Rules, 1962. “Concededly, that exercise has not been carried out,” the Court concluded.

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

“While doing so, 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 added. “The concerned officer will 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,” the Court further said.

Case Title: Milestone Systems A/S vs. Deputy Commissioner of Income Tax

Citation: 2023 LiveLaw (Del) 254

Counsel for the Petitioner: Mr Shashwat Bajpai with Mr Akshay Anurag and Ms Sanjana Sachdev, Advocates

Counsel for the Respondent: Mr Sanjay Kumar, Sr. Standing Counsel

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