Do software payments amount to royalties? Tracing the answer in the context of the engineering analysis case and proposing an alternative model

Abstract After almost two decades of litigation characterizing software payments for income taxation, the Hon’ble Supreme Court of India delivered a judgment on a batch of over a hundred appeals before it. The judgment respited the taxpayers. The present article analyzes the various arguments presented by the taxpayers and the Revenue Department and tests their applicability on the touchstone of International and Indian legal provisions and the established understanding of copyright law. The article concludes that the impact of copyright law on taxation cannot be avoided and any exploitation of copyright leading to income-generation is subject to tax. However, instead of bypassing copyright laws, a correct interpretation of the nuances of copyright laws would lead to more effective and less debilitating results.


Introduction
The importance of intellectual property in tax disputes has recently increased. What we consume on a daily basis and everything that has an impact on our lives is increasingly protected by copyright laws. Copyright is everywhere; just take a look at the daily soap operas produced by satellite TV networks, the films playing in theaters, or the content we watch on our smartphones from OTT services like Netflix, Amazon Prime, etc. The computer programs we use on a daily basis for work and play, as well as to control our home appliances like the dishwasher and the microwave, are indispensable. One of the most obvious ways in which copyright affects our daily The significant technical advancements of the previous several decades have not only led to a greater economic relevance, but also to a greater creation and diffusion of creative works, necessitating a greater need to safeguard these works. Along with all of this, the importance of tax revenues for governments from income from creative work has grown significantly. Numerous cases involving copyright and income tax disputes have been fought in courts between taxpayers and governments.
Consideration for the transfer of all or any rights in respect of the copyright of literary, artistic, or scientific works that are covered by the ITA's definition of royalty. Any consideration for the use of or right to use copyright in a literary, artistic, or scientific work is considered royalties in the context of a double-tax avoidance agreement. As a result, classifying a payment as a royalty or otherwise requires familiarity with the idea of copyright.
The Revenue has often contended that the Copyright Act, 1957 should not be relied upon for adjudicating on the obligation to tax under the Income-Tax Act, 1961 since the definition of "copyright" in Section 14 of that Act is preceded by the term "for the purposes of that Act." The Authority for Advance Rulings ("AAR") agreed with this interpretation in the Citrix Systems case, holding that the term "royalty" must be construed without regard to anything in the Copyright Act, particularly when interpreting the meaning of royalties in tax treaties, because it is defined in the Income Tax Act, 1961, as well as in the treaties.
Legally speaking, copyright is a property right and it exists independently of the protected work; the owner of a copy and the owner of the copyright of that work might be two separate entities. The negative right of copyright is another way of describing it. As opposed to a property right that grants "use" to just the owner, this one prevents others from duplicating the protected expression. Copyright is a negative right since it is the exclusive right to do those things and the equal and opposite responsibility for others to stop doing those things.
Often, copyright and artistic expression are conflated. The intellectual component is creativity or its expression, however this does not fall within the purview of copyright. Since originality is not a property right, there is no copyright in an idea. Even while the phrase is property, it is not protected by copyright on any particular media. A copyright is the legal privilege accorded to a work's creator (or their legal heirs).
The consideration for the transfer of all or any rights in respect of copyright is discussed in Explanation 2 to Section 9(1)(vi) of the ITA. In double tax treaties, royalty is the term used to describe the consideration for the use or right to utilize copyright. The economic context in which transactions take place and are taxed is reflected in copy right legislation. In order to determine how a given transaction is taxed, it is necessary to have a firm grasp of copyright law and the financial benefits it gives to the different parties like the author, the owner, and the user. Taxation is necessary because the reason for copyright legislation creates an economic value for copyright. The relationship between copyright and taxes is therefore essentially consequential, since the value of copyright affects the consideration, one pays for it and the income one obtains therefrom.
Copyright protection is fundamentally a give-and-take between motivating writers to generate original work and ensuring that they, and not freeloaders, will receive the economic advantages of their creative labor. Access to such creative work is essential to the advancement of society as a whole, and so its preservation is both necessary and desirable. The answer to the question of "where is value created with respect to a work and the copyright subsisting in such work?" may be found by digging into this issue.
Because (i) the copy of a work and the copyright in that work are distinct properties that can be dealt with separately, both will have respectable prices; (ii) the price of the copyright in a work depends on whether copyright exists in that work and the intrinsic value of the work; and (iii) both prices are aligned with what the market will pay for the work. Both of these values are subject to

The decision of supreme court in the case of engineering analysis center of excellence pvt. ltd in the context of software payments
The authors have analyzed various facets of the Engineering Analysis case and the intricacies involved are discussed as under:

Import of the phrase 'in respect of' in the explanation II (V)
Explanation 2 to Section 9(1)(vi) of the Income-Tax Act, 1961 contains the definition of Royalty and Clause (V), which reads as follows: (v) transfer of all or any rights (including granting of a license) in respect of copyright, literary, artistic or scientific works . . .
In Synopsis International Old, 4 the Karnataka High Court held that the words "in respect of" in Explanation 2(v) to Section 9(1)(i) denote the intention of the Parliament to give a broader meaning since these words admit of a wide connotation than the words "in" or "on." The High Court held that the phrase is to be given a wider meaning "relating to or with reference to" and has been used in the sense of being "connected with." The High Court preferred the literal meaning of the words used in the statute. Their meaning cannot be narrowed down by following a purposive interpretation, especially when their meaning is clear and unambiguous. By applying the broader meaning to the words "in respect of," the High Court sought to bring within the tax net all the incomes from the transfer of all or any of the rights in respect of copyright. The broader meaning supported the High Court's reasoning that in Explanation 2(v), it is not the consideration for transfer of all or any of the rights in the copyright but consideration in respect of copyright that falls within the definition of royalty. According to the High Court, it will receive consideration for the use of intellectual property for which the owner possesses copyright even without transferring a right in the copyright. The Count reasoned that ultimately, the consideration paid is for the usefulness of the material object with respect of which there exists copyright; therefore, the intention was not to exclude the consideration paid for the use of such a material object, which is called a copyrighted article. Even with respect to a copyrighted article, when the same is transferred, no doubt the right in the copyright is not transferred, but a right with respect to the copyright contained in the copyrighted article is transferred Therefore, the Parliament thought it fit to use in respect of as contra-distinct from the words 'in copyright. The meaning is clear, the intention is clear, and there is no ambiguity according to the Court-who held that any other interpretation would lead to the aforesaid provision becoming otiose. The Supreme Court rejected the High Court's reasoning to give a broader meaning to the words "in respect of." It referred to Swastik Tobacco, 5 where it was held that the expression with respect to, when used in a taxation statute, is only synonymous with the words "on" or "attributable to". Such meaning accords with the meaning to be given to the expression with respect to contained in Explanation 2(v) to section 9(1)(vi) of the ITA and would not, in any manner, make the expression otiose as was wrongly held by the High Court. 6

Nature of End-User License Agreement ('EULA')
The Supreme Court examined the various End-User License Agreements ("EULA") in the categories of the cases in appeal before it. The Court also observed that the expression "including the granting of a license" in clause (v) of Explanation 2 to section 9(1)(vi) would necessarily mean a license in which transfer is made of interest in rights "in respect of" copyright-that is, there is a parting with interest in any of the rights mentioned in section 14(b) read with section 14(a) of the Copyright Act, 1957. Section 30 of the Copyright Act, 1957 reads as follows: The owner of the copyright in any existing work or the prospective owner of the copyright in any future work may grant any interest in the right by license in writing signed by him . . .
The words "any interest in the right" in section 30 refers to only the rights in copyright contained in section 14 of the 1957 Act, and the Court rightly held that the license to use a software copy that was granted through the EULA was not a license in terms of section 30. The EULAs in all the appeals before the Court did not grant any such right or interest in copyright, including the right or interest in reproducing computer software. However, reproduction of the software was expressly prohibited, and the EULA declared that no copyright was at all transferred, either to the distributor or to the end-user. The license to use imposed restrictions or conditions for the use of computer software.
Regarding Category 3 of the previous cases, the Court referred to the EULA that the non-resident distributor entered with the end-user in India. Since the Court was seized of the issue of characterizing payments by such end-users to non-resident distributors, the Court examined the relevant underlying agreement. However, concerning payments falling under Category 2, Ruling describes the EULA, presumably signed between the non-resident software supplier and the end user in India together with the distribution agreement between the Indian distributor and the non-resident supplier. 7 There is no discussion in the ruling on the relevance of these EULAs when the payment by the distributor to the non-resident supplier was an issue for characterization. The purpose of referring to these 10 EULAs by the court is unclear. The Australian Tax Office considers it significant to who grants the EULA to the enduser but for an entirely different reason. According to the Draft Tax Ruling, an amount is royalty as defined under Explanation 2 of clause (vi) of section 9(1) of the Income-Tax Act where the consideration paid is for the grant of a license to the distributor permitting him to sub-license the use of software because he is authorized to do something in relation to the software that is the exclusive right of the copyright owner. However, the reasoning behind this conclusion is that even if there was copyright interest granted to the end-user through such a EULA it is the non-resident who grants that right, and not the distributor. Accordingly, the grant of any right by the non-resident software supplier through the EULA does not affect the rights and obligations of the Indian distributor and what he pays the consideration to the non-resident supplier. Had the EULA been granted by the Indian distributor to the end-user, there could be a possible argument that where the EULA did not grant any interest in copyright, it indicates that the distributor himself did not have those rights and consequently, that what he pays the non-resident is not for the use of copyright. Where any interest in copyright is granted to the end-user by the distributor, one can conclude that the distributor obtains those rights from the non-resident, and the payments made by him are in respect of those rights. However, a false-negative conclusion could result, for example, where the rights that the distributor obtains from the distribution agreement with the non-resident supplier are more than what is granted to the end-user through the EULA or where no copyright interest is granted to the end-user. In such cases, the EULA may not be a good indicator of the rights granted under a distribution agreement.

Non-exclusive license
Another notable aspect of the judgment is the reference to the non-exclusive nature of the EULA referred to by the Supreme Court several times during the ruling. For instance, "A reading of the aforesaid distribution agreement would show that what is granted to the distributor is only a non-exclusive, non-transferable license to resell computer software, it being expressly stipulated that no copyright in the computer programme is transferred either to the distributor or to the ultimate end-user. 8 When, under a non-exclusive license, an end-user gets the right to use a computer software in the form of a CD, the end-user only receives a right to use the software and nothing more. The end-user does not get any of the rights that the owner continues to retain under section 14(b) of the Copyright Act read with sub-section (a)(i)-(vii) thereof. 9 A non-exclusive, non-transferable license, merely enabling the use of a copyrighted product, is restrictive conditions which are ancillary to such use and cannot be construed as a license to enjoy all or any of the enumerated rights mentioned in section 14 of the Copyright Act or create any interest in any such rights to attract section 30 of the Copyright Act." 10 The Supreme Court implied the requirement of exclusivity for the use of copyright to be triggered, as can be seen from the above observations. However, even if the right licensed is non-exclusive, if the license pertains to the copyright owner's exclusive rights, copyright is used. The taxpayers emphasized the non-exclusivity of the license in their arguments before the Court, however, it is to be seen is as to what is being licensed-is any of the exclusive rights belonging to the copyright owner being licensed? If so, even if such a license is non-exclusive, copyright is used the exclusivity allowed for a licensee or an assignee was not the exclusivity of copyright.
In the Ruling the Supreme Court also dealt with various acts contained in Section 14(a) of the Copyright Act, 1957, as to how the exclusive right with the copyright owner may be parted. 11 Copyright is a negative right that prevents others from doing any of the exclusive acts listed in section 14. These exclusive acts are available only to the owner and not to others (which gives the in-rem character to copyright). The owner may decide to perform these "exclusive acts." The copyright owner's ability to permit others or transfer to others the right to do these acts does not come from Section 14 (which only lists these acts), but from Section 18 (assignment) and Section 30 (license) of the Copyright Act, 1957. These aspects were not discussed in Ruling.

Copyright versus copyrighted article
The taxpayers argued that the computer software imported for onward sale from other countries constitutes "goods," and thus, was directly covered by this Court's judgment in Tata Consultancy Services. 12 They also relied on the OECD Commentary which distinguishes the sale of a copyrighted article from the sale of copyright itself. On the other hand, the Additional Solicitor General ("ASG") argued that the judgments which deal with computer software under sales tax law and excise law have no relevance to income tax law, as the chargeability under the laws relating to indirect taxes are fundamentally different from the laws relating to direct taxes. He further argued that in some of the afore-stated EULAs, it was clearly stated that what was licensed to the distributor/end-user by the non-resident, the foreign supplier would not amount to a sale, thereby making it clear that what was transferred was not goods. 13 The Court rejected the ASG's argument and pointed out that the real nature of the transaction must be looked at upon reading the agreement as a whole. The Court referred to Sundaram Finance, 14 where the Apex Court held that: The true effect of a transaction may be determined from the terms of the agreement considered in the light of the surrounding circumstances. In each case, the Court has, unless prohibited by statute, power to go behind the documents and to determine the nature of the transaction, whatever may be the form of the documents.
Following that judgment, the Apex Court concluded that there was no doubt that the real nature of the transactions in the appeals, what was "licensed" by the foreign, non-resident supplier to the distributor and resold to the resident end-user, or directly supplied to the resident end-user, was, in fact, the sale of a physical object that contained embedded computer programs, and was, therefore, a sale of goods, which, is the law declared by this Court in the context of a sales tax statute in Tata Consultancy Services. 15 The reference to the Tata Consultancy Services judgment in CIT v. Samsung Electronics Co. Ltd. to find that the transactions in the appeal were a sale is debatable, since Ruling determined only the outcome if the transactions were a sale. In that judgment, the Apex Court concluded that a computer program embedded in a physical medium is a goods subject for sales tax. Ruling identifies the copyrighted article, which could be the subject matter of sale. Whether there was a sale depended on the transaction between parties, especially on whether the incidents of ownership over the copy were transferred. Notably, the Engineering Analysis Ruling did not elaborate on the aspects in the various EULAs and Distribution Agreements that pointed towards a transfer of title of the copies of software or other elements that constitute a sale of those copies.
Even if the facts in a particular case pointed towards a non-sale, that is, a license to use the software copy, the copy in question would still be a copyrighted article distinct from the copyright subsisting in that article. The Tata Consultancy Services Ruling discussed the medium and software contained in the medium, which is quite different from the copyrighted article and the copyright subsisting in that article which was not discussed or ruled upon in that case.
More to the point was the State Bank of India case 16 referred to in the judgment. The State Bank of India obtained a license to use copies of Kindle software pan India. As per the license, the bank could reproduce the software, and copies could be used for five years, after which it needed to pay a recurring license fee continuing to use the copies. The Bank applied for a refund of customs duty on the grounds that it paid for the right to reproduce software, which is royalty on which customs duty was not applicable. The Supreme Court drew an important distinction between the right to reproduce the software and the right to use software. The Court found that the license terms clearly showed that the software reproduced by the bank could only be used internally. The Court held: 21. Reproduction and use are two different things. Now under the agreement user is specifically limited to license sites. The transaction as a whole is to be seen. The press note is of no help to SBI. Rule 9(1)(c) and the interpretative note thereto did not apply as nothing was added to the price actually paid for the imported goods by way of royalties etc. Refund would be allowable only if there were something added on to the royalty payment which was not in the present case. The invoice originally presented was complete in itself. The second invoice was not filed along with the bill of entry. In the second invoice also, it is the license fee for the right to use countrywide and it is not the right to reproduce as claimed by SBI. Schedule I to the agreement is module and copies are modalities for the use of software by SBI with various restrictions. If we again refer to clause 6.4 of the agreement there is a complete restraint on SBI which says SBI shall not use, print, copy, reproduce or disclose the software or documentation in whole or in part except as is expressly permitted by the agreement nor shall SBI permit any of the foregoing. SBI is also barred from allowing access to its software or documentation except what is permitted under the agreement. Again, SBI is barred from selling, charging or otherwise making the software or documentation available to any person except what is expressly permitted under the agreement. Clause 6.5 of the agreement says that SBI shall not copy or permit copying of the software supplied to it by Kindle save as may be strictly required for delivery to license sites. The terms of the agreement also apply to the copies.
The limitations in using the reproduced copies indicated that the ownership of those copies was not with the Bank, but that the Bank was merely enabled to use the software. Even then, the limited right to use software did not indicate the use of copyright. Furthermore, the bank's right to copy was limited to reproducing the software for its use-for which it paid the license fee. One can say that the bank acted as per the directions of the copyright owner of the software to reproduce the copies on his behalf, and the copies were meant for internal use. The Court rightly concluded that the night to reproduce would amount to a parting of copyright by the owner while the right to use would not.
Another aspect that deserves further attention. Dassault Ruling extracted the commentary of Copinger to differentiate between the ownership of the copyright in a work and the ownership of work or its copy, as follows: "It is important to recognize that ownership of copyright in a work is different from the ownership of the physical material in which the copyrighted work may happen to be embodied".
Also, in DIT vs. Ericson, the assessee, a Swedish company was in the business of supply of hardware and software, which was used in the business of rendering telecommunication services and for this purpose, it undertook projects on turn-key basis. In this case, the issue relating to the royaltypayment, within the meaning of section 9(1)(vi) of the Act, has been dealt with in paragraph 59, on page 501 of the Report, in 343 ITR. The aforesaid paragraph 59 of the Report is reproduced as follows: "59. Be as it may, in order to qualify as royalty payment within the meaning of s It was also held in this case that even assuming that the payments made by the cellular operatorwere regarded as a payment by way of royalty, as defined in Explanation 2 below section9(1)(vi), nevertheless it could never be regarded as royalty, within the meaning of the termin Article 13, paragraph (3) of the DTAA. This is so, because the definition in the DTAAis narrower than the definition in the Act. Article 13(3) brings within the ambit of thedefinition of royalty, a payment made for the use of, or the right to use a copyright of aliterary work.
Finally, while approving the Dassault Ruling, the Supreme Court extracted the above portion with the word "embedded" in place of "embodied in the original Ruling" 17 Though appears trivial, the changed wording gives the impression that a copyrighted work is embedded on physical material when the copyrighted work is different from the medium (the physical material) comprising an expression of that work. This opinion was later reiterated by the Court in several subseuqnet judgments like Geoquest Systems B.V. Gevers Deynootweg, In Re and DIT vs. Nokia case.
In another case, DIT vs. Infrasoft Ltd., wherein the assessee, M/s.Infrasoft Ltd was primarily into the business of developing and manufacturing civil engineering software. One such software, which was subject-matter of controversy is called MX. The said MX software is used for civil engineering work and for design of highways, railways, airports, ports, mines, etc. The said software is used by private consultants. In view of the market position, the assessee opened a branch office in India. The branch in India imports the package in the form of floppy disks or CDs, depending on the requirements of their customers. The system is delivered to the clients / customer. The delivery of the system entails installation of the system on the computers of the customers and training of the customers for operation of the system. The branch office further undertakes the responsibility of updation and operational training, apart from providing support for solving any software issues. The respondent assessee develops customized software to be used by the customers for designing highways, railways, airports, ports, mines, etc. The software so customized is then licensed to an Indian customer and the branch office of the assessee in India, performs services involving interface to peripheral installation and training, etc.
The licensing agreement showed that the licence was non-exclusive, non-transferrable and the software was to be used in accordance with the agreement. Only one copy of the software was being supplied for each site. The licensee was permitted to make only one copy of the software and associated support information and that also for back-up purposes.
It was held that in order to qualify as royalty payment, it is necessary to establish that there is a transfer of all or any rights in respect of copyright of a literary, artistic or scientific work. Distinction has to be made between the acquisition of a "copyright right" and a "copyrighted article". It was further held that payments in these types of transactions would be dealt with as business income, in accordance with Article 7 of the DTAA. Right to use a copyright in a programme is totally different from the right to use a programme embedded in a cassette or a CD, which may be a software and payment made for the same cannot be said to be received as consideration for the use of or right to use of any copyright to bring it within the definition of royalty, as given in the DTAA. It was further held that the amount received by the assessee under the licence agreement for allowing the use of the software is not royalty under the DTAA between India and USA. What is transferred is neither the copyright in the software, nor the use of the copyright in the software. But, what is transferred is the right to use the copyrighted material or article which is clearly distinct from the rights in a copyright. The right that is transferred is not a right to use the copyright, but is only limited to the right to use the copyrighted material and the same does not give rise to any royalty income and would be business income.

Copyright versus copying right
The Supreme Court described the right to copy as being at the heart of the copyright. To arrive at this conclusion, the Court referred to the definition of "infringing copy" contained in the Act of 1957 with respect to a computer programme (which is a literary work) to mean a "reproduction of the programme." Accordingly, the right to produce a computer program and exploit reproduction by way of sale, transfer, license, etc., is central to this exclusive right.
Again, the Court noted from the EULAs in all the appeals before it that they did not grant any copyright right or interest, least of all, a right or interest to reproduce the computer software; and that such reproduction was expressly interdicted, and that no vestige of copyright is at all transferred, either to the distributor or to the end user. The Court provides an illustration to differentiate a situation where there is a use of copyright and one where there is no such use. In the view of the court, there is no use of copyright where an Indian distributor of a book acquires copies of the book from the publisher and sells the copies. On the other hand, when an Indian publisher obtains the right to reproduce a book and sell it in the Indian market, the copyright in that book is transferred. The Court concluded that what is licensed by the foreign, non-resident supplier to the distributor and resold to the resident end-user or directly supplied to the resident end-user without reproduction by the distributor is, in fact, the sale of a physical object which contains an embedded computer program and is, therefore, a sale of "goods" as per the law declared by this Court in the context of a sales tax law in Tata Consultancy Services The Court's reasoning to confer pre-eminence on the right of reproduction is debatable. Section 2(m) of CA 1957 defines an infringing copy of a literary work as a reproduction of the work thereof if such reproduction or copy is made or imported in contravention of the provisions of this Act. The use of words in the definition, if such reproduction, copy or sound recording is made or imported clearly implies that the word "copy" is used as a noun.
The use of the word "reproduction" in the definition of the term "infringing copy" is inevitable: a copy must be a reproduction. However, the court appears to have interpreted the word "reproduction" in the definition as a verb and concluded the term "infringing copy' as "the act of copying" the work instead of a "copy of the work". Based on this understanding, the court concludes that the right to reproduce a computer program and exploit reproduction by way of sale, transfer, license, etc., is at the heart of the said exclusive right. In other words, any of the exclusive acts comprising the copyright belonging to the copyright owner is infringed upon only when it is accompanied by reproducing the work, according to the court. This reasoning juxtaposes the definition of an "infringing copy" in section 2(m) with the exclusive rights contained in section 14(a) to come to a combined meaning that belies the plain words used in the law and contradicts the commentaries on the subject. 18

The principle of exhaustion
There has been a good deal of discussion in the Supreme Court on the exhaustion principle, although the conclusions drawn are confusing. The taxpayers argued that what was sold was a copyrighted article, and on the first sale, copyright was exhausted. Accordingly, the consideration paid was not towards any copyright, but for the copyrighted article-relying upon the Tata Consultancy Services ruling. On the other hand, the ASG argued that the doctrine of the first sale/principle of exhaustion would have no application since this doctrine is not statutorily recognized in Section 14(b)(ii) of the Copyright Act of 1957. This being so, since the distributors of copyrighted software "license" or sell such computer software to end-users, there would be a parting of a right or interest in copyright since such "license" or sale would then be hit by Section 14(b)(ii) of the Copyright Act, 1957.
The Court referred to Section 14(b)(ii) of the 1957 Act which contains the right to sell or give on hire or offer for sale or hire any copy of the computer program, regardless of whether such a copy has been sold or given on hire on earlier occasions, and held that with the omission of the underlined words in 1999, there is a statutory recognition of the doctrine of the first sale/principle of exhaustion.
The Court extracted Coppinger on doctrine of the first sale/principle of exhaustion as follows 19 :

" . . . One of the acts restricted by the copyright in all work is the issue of the original or copies of the work to the public, often called the 'distribution right'. This right is provided for in Section 18 of the 1988 Act. Infringement of the distribution right is a primary infringement under UK law, and so there is no need to prove knowledge or reason to believe that the copy in question is infringing. Thus, it is a powerful weapon against those at the top of a chain of distribution. In accordance with general principles, Section 18 must be interpreted so far as possible in such a way as to conform with relevant EU Directives, in this instance, the Software Directive and the Information Society Directive. Recent case law of the CJEU has made a conforming interpretation more difficult. An important aspect of the distribution right is that it is exhausted in relation to a particular article by the first sale (and, in the case of the Information Society Directive, the first transfer of ownership) of that article in the Community by the right-holder or with his consent . . . "
After describing exhaustion, the Supreme Court referred to Warner Bros. Entertainment ruling, in which the Delhi High Court dealt with copyrights in cinematograph films and explained the application of Section 14(d)(ii) of the Copyright Act, 1957. 20 Section 14 (d)(ii) is identical to Section 14(b)(ii), which deals with computer programs and contained the words "regardless of whether such copy has been sold or given on hire on earlier occasions" before they were omitted in 2012. In that case, Warner alleged that the defendant gave DVDs of films on rent without their consent even though the DVDs bore the warning that they were not permitted for sale or rental outside the USA and Canada territories. If done, it amounts to an infringement of Warner's rights under Section 14(d)(ii) of the Copyright Act, 1957. On the other hand, the defendants argued that the DVDs were legitimately purchased during trade and used to rent in India. The device of zoning (restraining the lawful licenses to use DVDs outside specified territories) adopted by Warner restricts the license owner to use it in territories other than what is indicated by them to be artificial and a "long-arm condition" that is unenforceable. The defendant relied on the Explanation to Section 14, which describes the content of the copyright and provides that "For the purposes of this section, a copy which has been sold once shall be deemed to be copy already in circulation".
The High Court noted that the contents of copyright with respect to each nature of work (literary, dramatic, or musical works, on the one hand; and computer programs, artistic works, cinematographic films, etc., on the other) is distinct-which is evident from the listing of such rights separately in clauses (a) to (f) of Section 14. The reference to "copies in circulation" must be, therefore, in the context that the phrase is used to limit the copyright owner's right to dictate further use of a literary, musical, and dramatic work. None of the owners of other work classes are subject to this limitation. The High Court held that the restriction of one class of copyright, structured in the statute, serves a dual purpose-that of limiting the owner of that class of copyright and at the same time, leaving it open to copyright owners of other kinds of work to place such restrictions. Since the Delhi High Court ruled before the deletion of the abovementioned provision, there seems to be no impact, whatsoever of it, on the ruling.
The Supreme Court noted that the words "regardless of whether such copy has been sold or given on hire on earlier occasion" manifested the legislative intent against the application of the doctrine of first sale/principle of exhaustion. Post 2012, on the omission of these words for cinematograph films in Section 14(d)(ii), the balance between the copyright owner's distribution right and the right of the purchaser to further resell was tilted in favor of the latter. The Supreme Court observed the same tilt for computer programs when similar words in Sections 14(b) (ii) were omitted in 1999. The Supreme Court held that:

"142. The language of section 14(b)(ii) of the Copyright Act makes it clear that it is the exclusive right of the owner to sell or to give on commercial rental or offer for sale or for commercial rental 'any copy of the computer programme'. Thus, a distributor who purchases computer software in material form and resells it to an end-user cannot be said to be within the scope of the aforesaid provision. The sale or commercial rental spoken of in section 14(b)(ii) of the Copyright Act is of 'any copy of a computer programme', making it clear that the section would only apply to the making of copies of the computer programme and then selling them i.e. reproduction of the same for sale or commercial rental."
The Court noted that under section 14(a)(ii), the distribution right subsists with the owner of the copyright to issue copies of the work to the public, to the extent that such copies are not copies already in circulation, thereby manifesting a legislative intent to apply the doctrine of first sale/ principle of exhaustion, as was found in Warner Bros. The Supreme Court thus held that the distribution of copyrighted computer software did not constitute a grant of an interest in copyright under section 14(b)(ii) of Copyright Act, 1957 since, according to the Court, the omission of the words "regardless of whether such copy such copy has been sold or given on hire on earlier occasions" in 1999 was a statutory recognition of the doctrine of first sale/principle of exhaustion.
The Supreme Court's reasoning is troublesome for two reasons. First, a plain reading of section 14(b)(ii) with the omission of the stated words does not give a different understanding from the reading of the provision before the words were deleted. The ASG argued that the doctrine of the first sale/principle of exhaustion would have no application since this doctrine is not statutorily recognized in Section 14(b)(ii). It is unclear whether the ASG came to this view on the plain reading of section 14(b)(ii) or because of the omission of these words. Irrespective, the provision before the omission in substance conveyed the same meaning as in Section 14(b)(ii) without those words and could be argued to be a surplusage.
Second, Notes on Clauses or the Memorandum explaining the amendment proposed in section 14(b)(ii) for computer programs are not available in the public domain. However, the Notes on Clauses on a similar deletion of the words in section 14(d)(ii) and 14€(ii) vide the Copyright Amendment Bill 2010 is illuminating. The Notes on Clauses for the 2010 amendments to these sections are as follows: "Clause (d) of section 14 relates to the exclusive right to do or authorize to do in case of a cinematograph film to make a copy of the cinematograph film, including a photograph of any image forming part thereof, to sell or give on hire, or offer for sale or hire, any copy of the film, regardless of whether such copy has been sold or given on hire on earlier occasions and to communicate the film to the public. It is proposed to amend the aforesaid clause to extend the exclusive right of the author including the storing of it in any medium by electronic or other means and to sell or give on commercial rental or offer for sale or for such rental, any copy of the film.
Clause (e) of section 14 relates to the exclusive right of the author in case of a sound recording. Sub-section (i) relates to making any other sound recording embodying it. It is proposed to amend the aforesaid sub-clause for extending the exclusive right of the author including the storing of it in any medium by electronic or other means. Sub-clause (ii) is proposed to be substituted by a new sub-clause providing that selling or giving on commercial rental or offer for sale or for such rental, any copy of the sound recording shall also come within the purview of exclusive right." While the documented intention behind the omission of those words in the 1999 amendment is not available, there should not be any serious reservation in taking recourse to a similar omission in section 14(d)(ii) and 14(e)(ii) in 2010 which explains the reasons. Unfortunately, the Notes on Clauses of the 2010 Amendment Bill were not brought to the attention of the Supreme Court and were not considered in the ruling. The intent of the legislature in omitting the words "regardless of whether such copy has been sold or given on hire on earlier occasion" appears contrary to what the Supreme Court believed the omission achieved-that is, to extend the copyright protection to the authors in respect of computer programmes, cinematograph films and sound recordings.

Proposing an alternative model for software payments
A move away from the regulatory landscape of copyright law is apparent from various developments in the tax arena. Consider software payments, for example. Software vendors who are right holders of copyright in aim to license and not sell copies, thereby extending their influence over those copies in perpetuity. Commentators have been critical of this "private ordering" through contact outside the copyright law. In a similar vein, governments are aiming to tax software independent of copyright law. The insertion of Explanation 4 to Section 9(1)(vi) of the IT Act, 1961 could be seen as an example in this direction only. The Indian Revenue's argument that right to use software copy is the use of copyright and, thus, any payment therefor is royalty, both under domestic law and tax treaties has been negated by the Supreme Court in Engineering Analysis. In hindsight, the insertion of Explanation 4 to widen the scope of royalty was necessary, from the Revenue's point of view.
The common aspect in both these stands is that both the right-holder and governments do not entirely divorce copyright law from their calculations. The rights-holder is beholden to the copyright law for the protection it bestows on the computer program and can monetize exclusive rights only because of that protection. Governments, also, do not disown copyright law for tax purposes. Consideration for the transfer of all or any rights with respect to copyright or for the use of or the right to use copyright in a computer program is subject to tax as royalty after Explanation 4 was inserted into the law. The attempt to tax payments for the use of software as royalty is in addition to the basic provisions in law and treaties.
This move away from relying on national copyright laws that have also been blessed by the OECD. The OECD Model Convention Commentary on Article 12 declares that national intellectual property laws must be referred to especially in the context of understanding the expression "alienation" but ends up drawing conclusions at variance from these laws. For instance, the OECD Commentary describes the act of a user to download, store, and operate digital content on his computer as the use of copyright even though copyright laws would term such use as a permitted act or fair dealing that amounts to user rights. 21 The Commentary concludes that payment for such "limited use" should not be characterized as royalties, but one could come to the same conclusion more elegantly by relying on the provisions of the relevant copyright law.
Another example is the distribution intermediaries dealt with by the Commentary in Para 14.4. The Commentary states that granting of the right to distribute copies of the software to such intermediaries without the right to reproduce the same are "limited to those necessary for the commercial intermediary to distribute copies of the software program. In such transactions, distributors pay only for the acquisition of software copies and not to exploit any right in the software copyrights." The Commentary appears to have laid emphasis on the right to make copies or reproduce as the use of copyright overlook the other copyright rights available with the copyright owner such as the distribution rights. Thus the Commentary deviates from copyright law in its interpretation of the meaning of copyright without offering any basis for such deviation. The proposal for Article 12 of the UN Committee of Experts in 2021 also adopted the same approach of avoiding copyright law to interpret software royalties, and at the same time, does not exclude payments for the use of copyright. However, the proposed method was rejected.
The developments at the UN Committee of Experts on the discussion of changes in the Double Tax Convention and/or Commentary relating to software payments acknowledge the disquiet existing among some developing countries, notably India. However, resistance from members of the Committee of Experts, especially from OECD countries to any change was visible. One member of the Committee from an OECD country from Western Europe candidly stated in one of the informal meetings of the Committee that she did not know the copyright laws but the interpretation with respect to the distribution intermediaries as given in the Annex to the Draft Report could hardly be correct. Her statement starkly brings out what needs to be corrected-it is not an increasing number of paragraphs in the Commentaries to clarify what the use of copyright is but an unhesitating embrace of the copyright law to characterize income arising therefrom, and resultantly, interpret taxation. There is more than enough literature on copyright litigation worldwide and a commentary dealing with income tax can hardly add anything to substance.
Progress in the discussion on software payments at the UN Committee is still considerable. The proposal of a new definition of royalties is another example of bypassing copyright laws. Although the new definition of royalties was rejected, the Committee did agree on the wording of an elaboration on the existing minority view included in paragraph 12 of the Commentary on Article 12 of the UN Model. Such an inclusion would justify amplifying the doubts on the interpretation of software royalties contained in the paragraphs of the OECD Commentary, especially paragraph 14.4 which are reproduced as part of paragraph 12. However, only the future will tell whether such a change in the Commentary on the UN Model is sufficient to dilute the conclusion reached in Engineering Analysis on the pre-eminence of the OECD Commentary to interpret software payments, especially where a particular DTAA is based on the UN Model Convention.
It is known that copyright law is a trade-off between incentivizing the creator to create backed by protecting him from freeloaders on the one hand and making available creative works for the public on the other. The Canadian Supreme Court described this balance between providing copyright protection and the other public policy objectives as "not only in recognizing the creator's rights but in giving due weight to their limited nature. In crassly economic terms it would be as inefficient to overcompensate artists and authors for the right of reproduction as it would be self-defeating to undercompensate them." 22 The Court noted that excessive control by copyright-holders and other forms of intellectual property may unduly limit the public's ability to incorporate and embellish creative innovation in the long-term interests of society as a whole or create practical obstacles to proper utilization. Fair dealing provisions or permitted acts that are non-infringing are exceptions to the rights of copyright owners who seek to protect the public domain.
The software cases regarding the first sale doctrine demonstrate the economic conflict between the holder of the intellectual property in a work and the owner of the tangible property that embodies copyrighted expressions. Copyright law cannot be interpreted as giving larger rights than what the copyright owner legitimately has been granted under the law so that the economic balance is retained, and the public interest is served. When dealing with taxation cases with respect to these economic outcomes, it would be discordant to treat them in a manner that is at variance with the position under copyright law.
When copyright owners seek to extend their influence over copies of their work in perpetuity, even though they have obtained the full price for the copies, they disturb the economic balance under copyright law. The restoration of the balance is the job of the courts or legislature in preventing such an extension of influence as was done by the Canadian Supreme Court in the Théberge case.
In that case, the appellants purchased lawfully reproduced posters of the artist's paintings and used a chemical process that allowed them to lift the ink layer from the paper (leaving it blank) and display it on the canvas. The artist (respondent) alleged that it was a dilution of his work, abusive commercialization without authorization; it was also a manipulation of the work because, in many cases, his signature did not appear on the reproduction and was anonymized. He alleged that his moral rights were infringed by this "ink transfer" and the potential impact on the market for his works was affected. The Court, however, refused to countenance the artist's attempt to assert a moral right in the guise of an economic right and rejected the same. Being the owners of the physical posters, the appellants were within their rights to do such an "ink transfer." There was no production (or reproduction) of a new artistic work "or any substantial part thereof in any material form" within the meaning of the Canadian Copyright Act.
One fallout of copyright owners' attempts to extend their economic influence over their works beyond what was contemplated as a proper balance under copyright laws has been the targeting of these transactions by the Revenue to tax them as copyright royalty. An obvious instance is the attempts made by governments worldwide to tax software payments disregarding national copyright laws. The focus of these attempts to tax payments for software is on the value of the work and not on the value of the protection granted by copyright laws.
The taxation of software payments is independent of whether such payments are with respect to copyright. One argument to justify such a treatment is that such payments for the use of software are for the use of copyright in the software, which it is not. The Engineering Analysis rule correctly affirmed this understanding. Irrespective of this argument, the insertion of an explanation to tax payments for the right to use or right to use as royalty, 23 and including software as a separate limb in the definition of royalties in tax treaties, 24 both disregard the existence or otherwise of copyright. Such taxation is independent of the legal and economic effects of copyright law.
The attempts described above for characterizing as royalties (or not) certain payments with respect to copyright (or not) disregarding copyright law are misplaced.
If one looks at the case law on the taxation of royalties, especially in India, or the OECD Commentary on Article 12, the taxing of income from licensing distribution rights has not been given due attention. This right to distribute is available to original literary, artistic, musical, or dramatic works. The OECD Commentary believes that the distribution right unless accompanied by copying is akin to a commercial right and should not be characterized as royalties, as endorsed by the Indian Supreme Court in Engineering Analysis case.
In the context of software, the copyright owner in India has escaped taxation of the income from licensing software distribution rights largely on the premise that the sale is of a copyrighted article and not of the copyright. However, this premise is fallacious on two grounds: -First, Indian copyright law includes the right to sell copies of a computer programme as a copyright right. That right licensed to a distributor is in respect for the copyright or for the use of the copyright and ought to be characterized as royalty both under the ITA as well as under the relevant treaty. The principle of exhaustion is effectively abolished in India by the TRIPS-plus provision in copyright law. However, while court rulings have not been categorical in this aspect, after Engineering Analysis, water is muddied further. The Supreme Court has interpreted exhaustion as applicable to the sale and rental rights (available for computer programs as well as for cinematograph films and sound recordings, although these works were not the subject matter of dispute before it) only when accompanied by the making of copies. The Apex Court's ruling will surely reverberate in the arena of films and music where similar provisions exist. This unintended effect of the ruling and its correctness in the context of copyright in computer programs will be examined in future cases.
Second, the grant of distribution rights to an intermediary to issue copies of the software on the market of a country requires examination in the context of distribution rights and the principle of exhaustion or the doctrine of first sale. This examination implies that the right to first introduce a copy into a country's market is with the copyright owner, irrespective of whether there has been a sale of that copy outside that territory. The transfer or license of such a distribution right is in respect of copyright as well as the use of copyright.
More likely than not, the copyright owner does not distribute the copies himself but distributes them through intermediaries. He authorizes these intermediaries to exploit the copyright in this work. Thus, where a distribution intermediary obtains from the copyright owner the right to distribute copies of the software in a country whose copyright law follows national exhaustion, the consideration therefor is with respect to copyright. Though the payment to the copyright owner may be for the copies (copyrighted articles), the consideration in some measure is to obtain the right to distribute the copies and is to be characterized as royalty both under the ITA and the relevant tax treaty. On the other hand, if the exhaustion is international, the payment made by a distributor to distribute copies where the first sale occurred outside the country is not to obtain the distribution right since that right was exhausted on the first sale that took place outside the country. Only in countries where exhaustion is international does the argument of copyright versus copyrighted articles have any meaning. Thus, the payment by the distributor to the copyright owner is not in respect of or for the right to use copyright and is not royalty under either the ITA or the tax treaty. Thus, an understanding of the first sale doctrine and the principle of exhaustion, whether national or international, helps to characterize the payment for copies of a work as royalty or otherwise. This line of argument has not been examined by courts for tax cases in India or elsewhere.
The argument that the software is licensed and not sold, and consequently the first sale doctrine or the principle of exhaustion shall not apply. Even if the argument is not rejected, its impact, at best, is muted. If income in the distribution chain is characterized correctly in line with copyright laws, there may not be a need to find new rules.
To conclude, instead of bypassing copyright laws (as is most evident in taxing software payments), a correct interpretation of the nuances of copyright laws would lead to more effective and less debilitating results. On the proper application of copyright laws to taxation, what will not be taxed is only the copies of a work sold directly by the copyright owner to the end-user. Data related to the proportion of sales of software vendors directly to users without entering the distribution chain are not available. However, remote selling is not unique to software or other digital content; it is prevalent even for tangible goods and services. A more rounded approach to taxing such remote selling by the source country or the country where the customer is located is the real solution subject to trade laws. All other measures were mere band-aid.
There are international developments to address the taxation of income earned from a country without a physical presence, namely, the introduction of a new Article 12B in the UN Model to tax digital services and the Pillar One proposal in the Inclusive Framework to grant additional taxing rights to market countries. However, the continuing taxability of copyright royalties under the ITA and treaties under existing rules must be considered when allocating taxing rights to source and market countries to avoid any cascading effect.

Conclusion and recommendations
The Engineering Analysis judgment brought to discussion the question of characterizing certain payments as royalties or not with respect to copyright. It would be difficult to avoid the impact of copyright law on taxation. It is natural that income arising from the exploitation of copyright has to be subjected to income tax. Such exploitation is possible, and income arise therefrom only because of the existence of protection provided by natural copyright laws. The quantum of income earned by a right holder is also dependent on the intrinsic value of the work which is the subject matter of protection. However, without the existence of protection, there is unlikely to be any income earned by the copyright owner.
Simply put, the right holder earns a higher income from exploiting the copyright in a computer program only if that program is any good. Thus, income correlates with the intrinsic value of work. However, income from exploitation of copyright arises only because the copyright holder enjoys protection under the national copyright laws. In the absence of such protection, no one would pay for a copy of the software if it can be freely copied and there would arise no income to tax, irrespective of the value of the work. The value of the work and the value of the protection under copyright law are different, and this distinction is often missed.
If one looks at the case law on the taxation of royalties, especially in India, or the OECD Commentary on Article 12, the taxing of income from licensing distribution rights has not been given due attention. This right to distribute is available to original literary, artistic, musical, or dramatic works. The OECD Commentary believes that the distribution right unless accompanied by something akin to a commercial right and should not be characterized as royalties, as decided in the Engineering Analysis case.
In the context of software, the copyright owner in India has escaped taxation of the income from licensing software distribution rights largely on the premise that the sale is of a copyrighted article and not of the copyright. This premise is fallacious on two grounds. First, Indian copyright law include the right to sell copies of a computer programme as a copyright right. That right licensed to a distributor is in respect of the copyright or for the use of the copyright and ought to be characterized as royalty both under the Income tax Ac and under the relevant treaty. The principle of exhaustion is effectively abolished in India by the TRIPS-plus provision in copyright law. However, while court rulings have not been categorical on this aspect, after Engineering Analysis, unfortunately, the waters are muddied. The Supreme Court has interpreted exhaustion as applicable to the sale and rental rights (available for computer programs as well as for cinematograph films and sound recordings although these works were not the subject matter of dispute before it) only when accompanied by the making of copies. The Apex Court's ruling will surely reverberate in the arena of films and music where similar provisions exist. This unintended effect of the ruling and its correctness in the context of copyright in computer programs will be examined in future cases.
Secondly, the grant of distribution rights to an intermediary to issue copies of the software in the market of a country requires examination in the context of distribution rights and the principle of exhaustion or the doctrine of the first sale. This examination implies that the right to first introduce a copy into a country's market is with the copyright owner irrespective of whether there has been a sale of that copy outside that territory. The transfer or license of such a distribution right is in respect of copyright as well as the use of copyright.
More likely than not, the copyright owner does not distribute the copies himself but distributes them through intermediaries. He authorizes these intermediaries to exploit the copyright in that work. Thus, where a distribution intermediary obtains from the copyright owner the right to distribute copies of the software in a country whose copyright law follows national exhaustion, the consideration is in respect of copyright. Though the payment to the copyright owner may be for the copies (copyrighted articles), the consideration in some measure is to obtain the right to distribute the copies and is to be characterized as royalty both under the ITA and the relevant tax treaty. On the other hand, if exhaustion is international, the payment made by a distributor to distribute copies where the first sale occurred outside the country is not to obtain the distribution right since that night was exhausted on the first sale which took place outside the country. Only in countries where the exhaustion is international, the argument of copyright versus copyrighted article has any meaning. Thus, the payment by the distributor to the copyright owner is not in respect of or for the right to use copyright and is not royalty under either the ITA or the tax treaty. Thus, an understanding of the first sale doctrine and the principle of exhaustion, whether national or international, help to characterize the payment for copies of a work as royalty or otherwise. This line of argument has not been examined by courts for tax cases in India or elsewhere.
Even if the argument that software is licensed and not sold, and, consequently, the first sale doctrine or the principle of exhaustion shall not apply is not rejected, its impact, at best, is muted. If income in the distribution chain is characterized correctly in line with the copyright laws, there may not be a need to find new rules.
To conclude, instead of bypassing copyright laws (as is most evident in taxing software payments), a correct interpretation of the nuances of copyright laws would lead to more effective and less debilitating results. On the proper application of copyright laws to taxation, what will not be taxed is only the copies of a work sold directly by the copyright owner to the end-user Data relating to the proportion of sales of software vendors direct to users without entering the distribution chain is not available. However, remote selling is not unique to software or other digital content; it is prevalent even for tangible goods and services. A more rounded approach to taxing such remote selling by the source country or the country where the customer is located is the real solution subject to trade laws. All other measures were mere band-aid.
There are international developments to address the taxation of income earned from a country without a physical presence, namely, the introduction of a new Article 12B in the UN Model to tax digital services and the Pillar One proposal in the Inclusive Framework to grant additional taxing rights to market countries. However, the continuing taxability of copyright royalties under the ITA and treaties under existing rules must be considered while allocating taxing rights to source and market countries to avoid any cascading effect.