Milestone Systems A/S vs Assistant Commissioner Of Income-Tax

PER VIKAS AWASTHY, JM:

This appeal by the assessee is directed against the Assessment Order dated 24.01.2025 passed u/s.143(3) r.w.s. 144C(13) of the Income Tax Act,1961(hereinafter referred to as 'the Act'), for AY 2022-23.

Brief facts of the case as emanating from the records are: The assessee company is incorporated in Denmark and is a tax resident of Denmark. The assessee is engaged in the business of providing IP Video Management Software and other video surveillance related products across the globe, including India. During the period relevant to the assessment year under appeal, the assessee earned revenue of Rs.19,83,35,342/- from sale of licensed software to its distributors in India. The assessee filed its return of income for AY 2022-23 declaring income of Rs.18,94,08,000/- and claimed refund of Rs.2,14,64,110/-. The income from sale of software licenses was not offered to tax by the assessee, as according to the assessee, the said revenue is not taxable in India under the India-Denmark Double Taxation Avoidance Agreement (DTAA). The stand of assessee is that the income from sale of off the shelf software licenses constitutes business income and since the assessee has no Permanent Establishment (PE) in India as per Article 5 of the DTAA, the business income of the assessee is not subject to tax in India.

Whereas, the Assessing Officer (AO), while passing the Draft Assessment Order (DAO), held that the software is not off-the-shelf software but is customized to the needs of end users, and the assessee exercises comprehensive control over operations of the distributors, including fixation of prices. The distributor is not at liberty to select the resellers. The products are sold in India through resellers certified by the assessee. Thus, the AO concluded that the assessee has a Dependent Agent Permanent Establishment (DAPE) in India and hence the revenue from software licenses is subject to tax in India. The AO thus attributed 50% of such profits to the alleged DAPE of the assessee in India. Against the DAO dated 30.03.2024, the assessee filed objections before the Dispute Resolution Panel (DRP). The DRP upheld findings of the AO with respect to existence of DAPE in India. However, the DRP restricted the rate of attribution to 25%. The Final Assessment Order was passed in accordance with directions of the DRP. Hence, the present appeal by the assessee.

Shri Sachit Jolly, Sr. Advocate, appearing on behalf of the assessee, submits that the addition was made by the AO and sustained by the DRP with regard to sale of off-the-shelf software in India on erroneous appreciation of facts. The ld. Counsel submits that neither the AO nor the DRP anywhere in the entire order/directions has been able to show that the necessary conditions for holding DAPE, as envisaged in Article 5(4) of the India-Denmark DTAA, are satisfied. The Revenue has failed to discharge its onus in establishing that the alleged dependent agent habitually concludes contracts on behalf of the assessee.

The ld. Counsel for the assessee submits that the assessee sells licensed software to its non-exclusive Indian distributors on principal-to-principal basis. The assessee does not, in any manner, instruct any of its distributors to select the resellers. The assessee has eight distributors in India who, select resellers on their own. The assessee has 195 certified registered resellers. The certification ensures that the assessee’s products are handled and sold by persons having necessary knowledge and skill. This helps protect brand reputation and ensures quality in customer service and installation of complex and sensitive products such as video management software in a flawless manner. The ld. Counsel reiterated that the assessee has no role in selection of resellers and the number of resellers. Selection of resellers is the discretion of the distributor. He referred to the Distributor Partner Agreement at page 21 of the paper book. Referring to Clause 2.1 of the agreement, the ld. Counsel stated that the distributors are non-exclusive authorized distributors of the products of the assessee. The distributor purchases and sells the products in its own name and for its own account, risk and costs. Further, referring to Clause 2.8 of the agreement, the ld. Counsel submits that the relationship between the assessee and the distributor is one of independent contractors acting for their own account and neither party is authorized to make any commitments or representations, express or implied, on behalf of the other, unless authorized to do so in writing. This clearly establishes a principal-to-principal relationship and independent contractor status. The assessee does not restrict the distributors from selling products and services of its competitors. The ld. Counsel furnished a table giving the names of distributors in India, their total turnover, purchases made from the assessee and the percentage of such purchases to total turnover, to substantiate that the products of the assessee constitute only a minuscule part of the distributors’ total turnover.

Per contra, the ld. Departmental Representative vehemently defended the assessment order and submitted that it is not a simpliciter sale of surveillance cameras or surveillance software. The assessee provides tailor-made solutions for each customer. The ld. DR referred to the observations of the AO at page 3 of the Draft Assessment Order. He pointed out that the AO has extracted excerpts from the website of the assessee indicating that the software sold is tailor-made as per the requirement of customers. Once it is established from the assessee’s own website that the assessee is providing tailor-made solutions and that prices are controlled by the assessee, the submissions made by the assessee with regard to sale of shrink-wrapped software should fail.

We have heard the submissions made by rival sides and have examined the orders of the authorities below. We have also considered the decisions and documents on which the ld. Counsel for the assessee has placed reliance. The assessee, during the relevant period, has inter alia earned revenue from sale of software licenses in India. The assessee sells its software licenses through the following chain: Assessee Distributor Reseller End user

The revenue earned by the assessee from sale of licensed software was not offered to tax in India as, according to the assessee, the said revenue is exempt under the India-Denmark DTAA. On the other hand, the stand of Revenue is, the income from sale of software is taxable in India for the following reasons: (i) The assessee has DAPE in India; (ii) The assessee is selling tailor-made software in India through DAPE; (iii) The assessee exercises control in selection/appointment of resellers; and (iv) The assessee controls pricing of the product in India.

The vital question that is required to be answered first is; Whether the assessee has DAPE in India?

To establish that the assessee has DAPE in India, the onus lies on the department. Before proceeding further, it would be relevant to refer to Article 5(4) of India-Denmark DTAA which sets out the conditions for having a DAPE in India. Clause (4) of Article 5 reads as under:-

A bare perusal of Article 5(4) shows that for an enterprise to be considered as a deemed PE, it must be established that the enterprise habitually exercises authority to conclude contracts on behalf of the foreign company or plays principal role leading to conclusion of contracts on behalf of the foreign enterprise. A perusal of the impugned order reveals that there is no finding that the distributors of the assessee in India conclude contracts on behalf of the assessee or play a principal role leading to conclusion of contracts on behalf of the assessee. Here, it would be relevant to refer to the sample Distributor Partner Agreement placed on record at pages 21 to 51 of the paper book.

Clause 2 of the agreements deals with the appointment of the distributor. The relevant excerpts from Clause 2 of the agreement are as under:

A plain reading of above clause/sub clauses would show that the assessee appoints Non-exclusive authorized distributor in India for sale of assessee’s products in its own name and for its own account, risk and cost. Thus, the relationship of the assessee with the distributors is on principal-to-principal basis. The above clause also clarifies that both the parties to the contract are independent contractors each acting for their own account. Neither the Distributor nor the assessee shall make commitments express or implied to bind the other party. Clause 2.7 authorizes the Distributor to sell directly to reseller, white reseller, End-users, OFM-Partner and third parties.

The Clause 3 of agreement deals with ‘The Distributor Partner Program’. Clause 3.3 grants liberty to the distributor to set its own resale prices subject to lawful maximum resale price. Thus, the assessee only restricts the ‘maximum resale price’ at which the product can be sold but does not restrict the Distributor in any manner to fix the resale price of the product. The fixation of maximum resale price is in accordance with the Indian laws that mandates display of ‘maximum retail price’ on the product label. Thus, the said covenant of the agreement does not in any manner bars the Distributor to fix the sale price for sale to resellers, except that the price fixed does not exceed the ‘maximum retail price’.

The Hon’ble Supreme Court of India in the case of Bharti Cellular India (supra) has held that sales price of prepaid products sold by distributors/franchise to retailers or customers was within sole desecration of distributors/franchise and assessee has no say in this matter, even under a condition to sell prepaid products on any price below printed to pack. The Hon’ble Apex Court in the said case accepted that the relationship between the cellular mobile telephone service provider and the distributor/franchisee is that of a principal-agent relationship. The restriction to sell the product below the maximum retail price/label is in no manner establishes that the assessee exercise control over distributors. In the instant case as well, the assessee sells software to its distributors and does not dictate the pricing of the software to be charged by the distributors from resellers/end users, except for prescribing the condition that the price should not exceed the maximum retail price.

Clause 14 of the agreements allow the Distributor to sell the products of competitors. Thus, the assessee in any manner does not jeopardize the interest of distributors in selling the products of other suppliers. The assessee has furnished a chart highlighting the total revenue of the Distributors vis a vis the products of the assessee purchased by the Distributors. The said chart is reproduced herein below:

A perusal of above chart would show that, barring one distributor, the products of the assessee sold by six distributors constitute less than 1% of their total turnover.

The AO has held that the assessee is substantially controlling affairs of the distributors’ business, as the assessee exercises control in selection/appointment of resellers and also controls the pricing of products in India. Insofar as appointment of resellers is concerned, the contention of the assessee is that it only certifies the resellers recommended by the distributors. The assessee has 195 certified registered resellers and the distributors are at liberty to engage any of the certified resellers across India for selling the products. The assessee has explained that the reason for certification of resellers. The certification ensures that the resellers handling the products and installing complex and sensitive products such as video management software possess the minimum level of knowledge and skill and ensures quality check on services rendered by resellers. We find that such a certification program does not, in any manner, curtail business liberty of the distributors. Hence, mere certification of resellers by the assessee cannot be a reason to hold that the assessee controls business of the distributors. In any case distributors are non-exclusive and are liberty to sell products of assessee’s distributors.

Such an arrangement cannot, in any manner, be construed to mean that the assessee exercises control over pricing of the products. Therefore, the findings of the AO on the above two counts to hold that the assessee controls the business of distributors are devoid of merit.

The next contention of the Revenue is that the assessee is not selling standard software but is customizing the software according to the requirements of each customer. To arrive at such a conclusion, the AO has referred to excerpts from the official website of the assessee. Whereas, the contention of the assessee is that it sells standard shrink-wrapped off-the-shelf software without any modification to customers. We find that except for the observations made by the AO based on excerpts from the website of the assessee, nothing has been brought on record to show that the software sold by the assessee is tailor-made. In this regard, it would be relevant to refer to the excerpt from the website of the assessee on which the AO has placed reliance:-

A perusal of the above excerpt from the website shows that nowhere does it state that the assessee provides tailor-made software solutions. It only indicates that the software of the assessee is flexible and adaptable to the requirements of end users with regard to scalability and updates incorporating the latest analytics and AI technologies. In simple words, the software has broad spectrum to meet the requirements of different categories of End users.

The Revenue has not been able to substantiate that the assessee satisfies any of the conditions (a) to (c) set out in Article 5(4) of the DTAA. Neither do the distributors habitually conclude contracts on behalf of the assessee, nor do they habitually maintain stock of goods or merchandise from which regular deliveries are made on behalf of the assessee. Further, the distributors do not habitually secure orders on behalf of the assessee. The agreement explicitly states that the distributors purchase and sell the products in their own name and for their own account, risk and cost. Except for bald assertions, no material has been placed on record by the Revenue to contend that the assessee has DAPE in India. Thus, the findings of the AO with regard to the assessee having DAPE in India are without merit. Thus, the question framed above is answered in negative. Once it is held that the assessee has no PE/DAPE in India, the question of attribution of profits to the alleged PE does not arise.

In light of the above findings, the impugned order is set aside and appeal of the assessee is allowed