SC ruling: Payments to non-resident firms for software not taxable as royalty

By: |
March 3, 2021 4:30 AM

This means tax liability of foreign software seller without a permanent establishment in India would reduce to the 2% equalisation levy introduced via Finance Act 2020, from the 10% royalty tax, which the Indian buyer has hitherto been liable to withhold.

After the SC ruling, such software firms have now been exempted from deducting TDS for purchase of software from foreign software suppliers.After the SC ruling, such software firms have now been exempted from deducting TDS for purchase of software from foreign software suppliers.

The Supreme Court on Tuesday ruled that payments made to non-residents for software purchase can’t be taxed as royalty, setting at rest a long-standing row. This means tax liability of foreign software seller without a permanent establishment in India would reduce to the 2% equalisation levy introduced via Finance Act 2020, from the 10% royalty tax, which the Indian buyer has hitherto been liable to withhold.

The ruling will lower the cost of software purchases for Indian firms as the overseas sellers may chose to lower prices, taking advantage of the tax relief. Software firms such as IBM India, Samsung Electronics, GE India, Hewlett Packard India, Mphasis and others, which import software for sale in India, are among the principal beneficiaries.

After the SC ruling, such software firms have now been exempted from deducting TDS for purchase of software from foreign software suppliers.

Vishal Malhotra, national tax leader-TMT at EY India, said: “This is a welcome judgment which not only brings certainty on the two-decade-long debate, but also vindicates the non-taxability stand on software payments by reinforcing supremacy of tax treaties entered into by two sovereigns over the domestic law.”

Earlier court rulings on the dispute were conflicting. In the case of Samsung Electronics, Karnataka High Court had ruled in favour of the taxman while the Delhi High Court, in the Ericsson case, upheld the taxpayer’s contention. The subsequent rulings by other HCs have been divergent.

“Though many cross-border software payments would be relieved from royalty tax, these transactions could still be covered under the expanded equalisation levy that was introduced in April last year,” said Rakesh Nangia, chairman, Nangia Anderson India.

Settling the 20-year dispute, a Bench led by Justice RF Nariman said “…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 through the End-User Licence Agreements/distribution agreements, is not the 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, as a result of which the persons (resident Indian importers) referred to in Section 195 of the Income Tax Act were not liable to deduct any TDS under Section 195 of the Income Tax Act.”

Deciding around 86 appeals and cross-appeals both by the software companies and the income tax department led by Engineering Analysis Centre of Excellence Pvt Ltd vs Commissioner of Income Tax, the top court while citing the definition of royalties contained in Article 12 of the double taxation avoidance agreements (DTAAs) clarified that,“there is no obligation on the persons mentioned in Section 195 of the Income Tax Act to deduct tax at source, as the distribution agreements/EULAs in the facts of these cases do not create any interest or right in such distributors/end-users, which would amount to the use of or right to use any copyright.”

According to the judgment, “the provisions contained in the Income Tax Act (Section 9(1)(vi), along with explanations 2 and 4 thereof), which deal with royalty, not being more beneficial to the assessees, have no application in the facts of these cases.”

It said that the End User Licence Agreements of the software do not transfer or assign the copyright over the software and what is given the distributor is only a non-exclusive, non-transferable licence to resell computer software. It is being expressly stipulated that no copyright in the computer programme is transferred either to the distributor or to the ultimate end-user, the SC said in its 226-page judgement.

The income tax department termed payments made to non-residents for software purchase as royalty. The rationale for this stance has been that when software is sold, the incorporated programme is licensed to the end user. The taxman has also contended that since the Indian entity is granted the rights to exploit the software copyright, the payments for such purchases amount to royalty income for the seller.

Taxpayers have opposed this view, saying that these transactions are sale simpliciter and do not entail licensing of any copyright. The non-resident owner retains the proprietary rights in the software and the use of the software by the Indian company is limited to making backup copy and redistribution, they argued. Payment received for sale of computer software is business income and in the absence of a business presence or permanent establishment of the seller in India, such business income is outside the ambit of taxation, the companies argued.

Get live Stock Prices from BSE, NSE, US Market and latest NAV, portfolio of Mutual Funds, Check out latest IPO News, Best Performing IPOs, calculate your tax by Income Tax Calculator, know market’s Top Gainers, Top Losers & Best Equity Funds. Like us on Facebook and follow us on Twitter.

Financial Express is now on Telegram. Click here to join our channel and stay updated with the latest Biz news and updates.

Next Stories
1Suitors asked to place financial bids for Air India
2Liberal regulation for vaccine approval to improve access to jabs, says health secretary
3RBI policy: Calms some nerves; just what the doctor ordered