DTAA Overrides Domestic Tax Law | ITAT Mumbai Rules Software Supply Not Royalty, No AOP in Consortium Contracts

The Income Tax Appellate Tribunal, Mumbai, has delivered a landmark consolidated order affirming that software supply by a non-resident cannot be taxed as royalty under the India-Germany Double Taxation Avoidance Agreement (DTAA), and that a consortium arrangement between two entities does not constitute an Association of Persons (AOP) where there is no shared profit, joint management, or common purpose to earn income. The decision reinforces treaty-based taxation principles and provides critical clarity for multinational enterprises operating through joint ventures in India.

Background & Facts

The Dispute

The appellant, Siemens Aktiengesellschaft, a German multinational corporation, engaged in the design, manufacture, and supply of medical diagnosis equipment and related software systems. It entered into consortium agreements with its Indian associate, Siemens Limited (India), to execute large-scale infrastructure projects for clients such as the Delhi Metro Rail Corporation (DMRC). The core dispute centered on whether payments received by Siemens AG for offshore supply of software and equipment, and for offshore technical services, constituted taxable royalty income in India, and whether the consortium arrangement between Siemens AG and Siemens Limited (India) amounted to an AOP liable to be taxed as a separate entity.

Key Facts

• Siemens AG is incorporated in Germany and has no permanent establishment (PE) in India.
• For assessment years 2012-13 to 2016-17, Siemens AG received payments from Indian entities for:
  • Offshore supply of standardized software embedded in medical equipment
  • Offshore rendering of technical services
  • Offshore supply of equipment
• Siemens Limited (India), a separate Indian entity, handled onshore supply, installation, commissioning, and maintenance.
• A Memorandum of Understanding (MOU) dated 11.09.2006 defined separate scopes of work:
  • Siemens AG: Offshore supply of equipment and software, technical support
  • Siemens Limited (India): Onshore supply, installation, commissioning, training
• Each party invoiced DMRC independently for its respective scope of work.
• Payments were received directly by each party in their respective jurisdictions.
• The MOU explicitly stated: "Nothing in the BS03 Contract shall be deemed to constitute, create, give effect to or otherwise recognize a corporation, association, partnership, joint venture or formal or informal business entity of any kind."
• The Indian tax authorities contended that:
  • Software payments constituted royalty under Section 9(1)(vi) of the Income Tax Act, 1961
  • The consortium formed an AOP under Section 2(31)
  • Income from offshore supply was taxable as business income due to the "composite contract" doctrine

Procedural History

• 31/01/2017: Final assessment order for A.Y. 2012-13 issued by Assessing Officer (AO)
• 30/06/2017: Revised assessment order for A.Y. 2012-13
• 23/10/2018: Final assessment order for A.Y. 2014-15
• 25/09/2019: Final assessment order for A.Y. 2015-16
• 30/04/2021: Final assessment order for A.Y. 2016-17
• All orders were passed under Section 143(3) read with Section 144C(13) following directions from the Dispute Resolution Panel (DRP)
• The DRP directed the AO to reconsider the taxability of offshore supply and software payments, but did not conclusively decide the AOP issue
• The appellant filed appeals before the ITAT for all five assessment years
• The appeals were consolidated due to identical factual and legal issues
• The Tribunal relied on its own prior decision in I.T.A. No. 2153/Mum/2014 & 2179/Mum/2014 (A.Y. 2009-10), dated 07/06/2024, as binding precedent

The Parties' Positions

For the Appellant (Siemens Aktiengesellschaft)

• Software supplied was standard off-the-shelf, non-customized, and non-transferable
• License granted was non-exclusive, non-transferable, and restricted to single-user use
• No right to modify, reverse engineer, or commercially exploit the software
• Payments were for sale of goods and services, not for use of copyright
• Relied on Engineering Analysis Centre of Excellence Pvt. Ltd. v. CIT (2021) 432 ITR 471 (SC) to establish that software supply is not royalty
• Contended that the MOU created no joint venture, AOP, or partnership
• Emphasized separate invoicing, separate payments, separate liability, and indemnification clauses
• Relied on Linde AG v. DDIT (2014) 365 ITR 1 (Delhi) and Hyundai Rotem Co. v. DIT (AAR) to show absence of AOP
• Argued that the India-Germany DTAA, particularly Article 12, mandates taxation only on receipt basis for royalties and FTS

For the Respondent (Revenue)

• Contended that software payments constituted royalty under Section 9(1)(vi) and Article 12 of the DTAA
• Relied on Roxar Maximum Reservoir Performance WLL (AAR) and Alstom Transport SA (AAR) to argue that composite contracts cannot be dissected
• Invoked Vodafone International Holdings BV v. Union of India (2012) 345 ITR 1 (SC) to assert that transactions must be "looked at" as a whole
• Argued that the consortium arrangement between Siemens AG and Siemens Limited (India) met the criteria for an AOP under Section 2(31)
• Claimed joint and several liability under the contract indicated common purpose and shared risk
• Sought to tax offshore supply as business income under Section 9(1)(i) due to the "composite contract" doctrine
• Contended that transfer pricing adjustments were justified due to discrepancies in reporting between the Indian AE and the foreign assessee

Relief Sought

The appellant sought:

• Deletion of royalty additions on software payments
• Deletion of AOP assessments
• Deletion of transfer pricing adjustments
• Exclusion of offshore supply income from Indian taxation
• Deletion of interest under Sections 234B and 234C
• Cancellation of penalties under Sections 271(1)(c) and 271G
• Recognition of receipt basis taxation for royalties and FTS under the India-Germany DTAA

The Legal Issue

The central questions were: (1) Whether payments received by a non-resident for supply of standardized software constitute royalty under Section 9(1)(vi) of the Income Tax Act or Article 12 of the India-Germany DTAA? (2) Whether a consortium arrangement with separate invoicing, independent scope of work, and no profit-sharing constitutes an Association of Persons under Section 2(31)? (3) Whether income from offshore supply of goods and services is taxable in India under the DTAA when the transaction is completed outside India and no permanent establishment exists?

Arguments Presented

For the Appellant

The appellant relied on the Supreme Court’s decision in Engineering Analysis Centre of Excellence Pvt. Ltd. v. CIT (2021) 432 ITR 471, which categorically held that payments for software supply, whether embedded in hardware or sold separately, do not constitute royalty under the Act or DTAA if the licensee receives only a non-exclusive, non-transferable right to use the software for its intended purpose. The appellant emphasized that the software was exclusively compatible with its own equipment and had no standalone utility. It further cited Linde AG v. DDIT (2014) 365 ITR 1 (Delhi) and Hyundai Rotem Co. v. DIT (AAR) to demonstrate that joint liability to a third party, without shared management or profit, does not create an AOP. The appellant also relied on the explicit language of the MOU, which disclaimed any formation of a legal entity, and on the India-Germany DTAA’s Article 12, which uses the term "paid" and "received," indicating taxation only on receipt basis.

For the Respondent

The Revenue relied on the AAR rulings in Roxar Maximum Reservoir Performance WLL and Alstom Transport SA, which applied the "look at" principle from Vodafone to treat composite contracts as indivisible and taxable in India. It argued that the consortium’s joint and several liability to DMRC, coupled with the lump-sum nature of the contract, indicated a common enterprise. The Revenue contended that the MOU’s indemnity clause and shared project objectives demonstrated a common purpose to earn income, satisfying the criteria for an AOP under CIT v. Indira Balkrishna (1960) 39 ITR 546 (SC). It further asserted that the transfer pricing adjustment of 10% was justified due to inconsistent reporting between the Indian AE and the foreign assessee.

The Court's Analysis

The Tribunal conducted a meticulous review of the factual matrix and legal precedents. It began by affirming that the issues were identical across all assessment years and had been conclusively decided in the appellant’s favor in A.Y. 2009-10, a decision binding under the doctrine of consistency.

Regarding software royalty, the Tribunal quoted the Supreme Court in Engineering Analysis Centre:

"The amounts paid by resident Indian end-users/distributors to non-resident computer software manufacturers/suppliers, as consideration for the resale/use of the computer software, is not payment of royalty for the use of copyright in the computer software and that the same does not give rise to any income taxable in India."

The Tribunal found that the appellant’s software licensing terms - non-exclusive, non-transferable, restricted to single-device use, no reverse engineering permitted - were identical to those in Engineering Analysis Centre. It held that the software was not a copyright product but a functional good, and its supply was a sale of goods, not a license of intellectual property.

On the AOP issue, the Tribunal examined the four essential ingredients for an AOP: (1) joining together, (2) volition to come together, (3) for the purpose of producing income, and (4) sharing of profits or losses. It found all four absent. The MOU explicitly disclaimed any entity formation. Each party bore its own costs, raised its own invoices, received its own payments, and bore its own risks. The joint liability to DMRC was contractual, imposed by the employer for security, not indicative of a joint enterprise. The Tribunal relied on Linde AG and Hyundai Rotem Co., noting:

"Mere existence of common interest or joint liability to a third party is insufficient to constitute an AOP. There must be a common design to produce income and sharing of profits or losses."

The Tribunal further distinguished Vodafone and Roxar, holding that those cases involved situations where the offshore component was artificially undervalued to evade tax. Here, the offshore and onshore components were clearly demarcated, independently priced, and separately performed. The Tribunal stated:

"The Supreme Court in Vodafone did not overrule Ishikawajima-Harima in all contexts. Where the offshore and onshore elements are distinct, separable, and independently priced, the dissecting approach remains valid."

On transfer pricing, the Tribunal held that the 10% ad hoc adjustment was unjustified. The appellant had submitted a TP study report and demonstrated that differences in reporting arose because the Indian AE recorded transactions on accrual basis while the appellant followed the DTAA’s receipt basis. The Tribunal held that such differences, when explained and consistent with treaty obligations, cannot form the basis for arbitrary adjustments.

The Tribunal also held that interest on arbitration awards from NTPC was not taxable in the absence of a PE, relying on CIT v. Govinda Choudhury & Sons (1993) 203 ITR 881 (SC), which held such interest to be incidental to business and not a separate income head.

The Verdict

The appellant succeeded on all material grounds. The Tribunal allowed the appeals for all assessment years (2012-13 to 2016-17). The Assessing Officer was directed to:

• Delete all additions on account of software royalty
• Delete all assessments on the ground of AOP
• Delete transfer pricing adjustments of 10% and recompute ALP based on the appellant’s TP study
• Exclude offshore supply and offshore services income from taxation in India
• Delete interest under Section 234B and 234C, and recompute if necessary
• Dismiss penalties under Sections 271(1)(c) and 271G as infructuous
• Tax royalty and FTS income only on receipt basis as per Article 12 of the India-Germany DTAA

The order was effective for all five assessment years under consideration.

What This Means For Similar Cases

Software Supply Is Not Royalty Under DTAA

• Practitioners must now argue that standardized software supplied with equipment, under non-exclusive, non-transferable licenses, does not constitute royalty under Section 9(1)(vi) or DTAA Article 12
• The Engineering Analysis Centre precedent is now firmly entrenched in ITAT jurisprudence
• Tax authorities cannot rely on old AAR rulings like Roxar to tax software as royalty if the licensing terms mirror those in Engineering Analysis Centre

Consortium Arrangements Do Not Automatically Create AOP

• Joint liability to a third party, even if joint and several, does not create an AOP
• Separate invoicing, separate payments, independent scope of work, and explicit disclaimers of entity formation are decisive factors
• The Linde AG and Hyundai Rotem Co. principles now form the governing test for AOP determination in consortium cases
• Tax authorities must prove actual profit-sharing and joint management - mere coordination is insufficient

Receipt Basis Prevails Over Accrual for DTAA Income

• For non-residents covered by treaties using "paid" or "received" language, income must be taxed on receipt basis, not accrual
• Differences in accounting treatment between Indian AEs and foreign entities are not grounds for transfer pricing adjustments if treaty-compliant
• The doctrine of consistency requires uniform application of treaty interpretations across assessment years

Transfer Pricing Adjustments Must Be Method-Based

• Ad hoc adjustments (e.g., 10% mark-up) without benchmarking are impermissible
• If an Indian AE has already been assessed on an arm’s length price for the same transaction, the foreign entity must be granted the same ALP unless material differences exist
• TP studies submitted by the assessee must be evaluated on their merits, not dismissed due to accounting differences

Offshore Supply Remains Exempt if Discrete and Separately Priced

• The "composite contract" doctrine cannot be used to tax offshore supply if the contract clearly separates offshore and onshore elements
• The Ishikawajima-Harima principle remains valid where the offshore component is distinct and not artificially undervalued
• The Protocol to Article 7 of the India-Germany DTAA explicitly excludes offshore supply profits from PE attribution