Vivian Fernandes, CNBC-TV18:

The Income Tax department has held that the price charged for the use of Microsoft's software in India is license fee and therefore royalty and tax is payable on it. It has determined the royalty income at Rs 2,240 crore, nearly three times more than originally assessed.

Windows of opportunity is what the Commissioner of Income Tax Appeals has seen in the software that Microsoft licenses for use in India, through a layer of companies starting with its exclusive licensee Gracemac Corporation, USA, which in turn has a non-exclusive licensee in Microsoft Operations PTE Singapore. This company, in turn, has made Microsoft Regional Sale Corporation, USA, a non-exclusive licensee to distribute Microsoft products in Asia to end users.

The Commissioner Appeals said the products that MRSC distributes are not a sale, and gives reasons why the price realised is license fee. Income from software license is royalty income, under both domestic law and the double taxation agreement with USA, said the Commissioner.  

The Appeals Commissioner has assessed the royalty income at Rs 2,240 crore for the six years to 2005 and not Rs 868 crore as originally assessed. Gracemac Corporation had gone in appeal saying that the income is not royalty, and not taxable in India. The tax website Taxindia online.com estimates the tax liability, including overdue interest at Rs 700 crore.

Responding to the IT department's stance, Microsoft has said, “The case in point is an old issue relating to FY99 to FY04, and for an overseas Microsoft entity. Microsoft believes it is in full compliance with Indian tax laws and the Income Tax treaty agreement between India and US. This is an appellate order, Microsoft is reviewing the order, and we will determine our course of action accordingly."

Curiously, the Director General International Taxation has told CNBC-TV18 that he has to take a view on accepting the ruling. Tax mavens say the ruling is flawed because royalty arises only when intellectual property right is transferred, not for use of copyrighted software. They say the ruling overturns existing rulings and could have an adverse impact on Indian software companies as well, if not contested or upheld upon challenge.

Tax Attorney, Porus Kaka is not sure whether this ruling at the first appellate authority level is correct at all as this kind of a transfer of software by way of a license does not amount to royalty taxable in India

Excerpts from the exclusive interview with Porus Kaka:

Q: What are the implications for Microsoft if the Tax Department's view is confirmed?

A: The implications are listed on the site in the sense that financial implications of about Rs 700 crore worth of TDS liability without any other issues. But I am not sure whether this ruling at the first appellate authority level is correct at all.

Q: Why do you think that?

A: Undoubtedly, when there is a transfer of software, there is always a license that is granted. But he (the Commissioner) himself accepts that when the grant of the license is made to anyone, any of us who buy Microsoft's products, the grant of the license is to use the product. We have no right to IPR or the Intellectual Property Right for licensed amount to royalty under the tax treaties or even under our domestic income tax law. It must be the license of the copyright. Once you accept that there is no license in the copyright then I do not understand how the amount can be royalty even if it is a license for and not a direct sale as the Commissioner calls it.

So, therefore I think, there is a distinction between licensing of products, which is to be used like a Windows or an XYZ or license of a copyright that allows us to copy and market the product. When we do not have the latter, you cannot call it royalty under the treaty and this is accepted internationally and I think that is the correct position. So, I think the ruling to that extent is clearly wrong, apart from the fact that it has not followed the commentary of the OECB, which undoubtedly is not binding.

But what I think it has overlooked or I am not sure because we do not have the full text is that there are decisions of our own tribunals and costs on this point and they I think squarely cover the issue that this kind of a transfer of software by way of a license does not amount to royalty taxable in India.

Q: Would Microsoft have a strong case if it went and appealed?

A: The facts from what I have seen, certainly it would have.