By S Ramadorai & TP Ostwal
Patience and perseverance certainly pay off and one such prominent example is the recent order passed by the Supreme Court of India (SC) that ruled in a 20-year-old software royalty tax case in favour of software companies, including Tata Consultancy Services. The taxation of income in the hands of non-resident seller of off-the-shelf copies of shrink-wrapped computer software in cross-border transactions has been a contentious issue over three decades. The core issue was that when payment for the purchase of software was made to a non-resident seller, it was treated by the taxation authorities as “Royalty” or “Business Income” in the hands of the seller.
The SC bench was hearing a batch of 86 appeals dealing with the above issue which were grouped by the Court into four categories: (i) software purchased directly by an end-user from a non-resident supplier; (ii) software purchased from a non-resident supplier by an Indian distributor and resold to Indian end-users; (iii) software purchased from a non-resident supplier by a non-resident distributor and resold to Indian distributors or end-users and (iv) software sold as integrated hardware unit by non-resident suppliers to Indian distributors or end-users.
At the outset, the SC examined the distribution agreements between some of the Indian companies and the foreign software vendors. On further examination, the Court noted that what those agreements conferred upon the Indian companies was merely a non-exclusive, non-transferable licence in respect of computer software. No rights of copyright were granted in the software to the Indian companies and even Indian end-users had no right to sub-licence, transfer, reverse engineer, modify or reproduce the software otherwise than as permitted under the End User License Agreements (‘EULA’).
The Court referred to section 14 of the Copyright Act which makes it clear that a copyright is an exclusive right to do or authorise the doing of certain acts in respect of work (which includes literary work and hence, computer software).
A transfer of copyright would take place only when the owner of the copyright parts with the right to do any of the acts mentioned in section 14 of the Copyright Act. The Court observed that the “right to reproduce” and the “right to use” computer software are two distinct rights, as the former would involve a transfer of copyright.
Use of the term “licence” in a EULA / distribution agreement with imposition of restrictive conditions on the use of the product, could not be construed as a licence under section 30 to do the acts enumerated in section 14 of the Copyright Act, thereby quashing the Karnataka High Court (supra) stand that the said licence fitted well under the definition of Copyright. In view of the above ruling, the SC opined that, undoubtedly, what the foreign vendors had “licenced” to the Indian distributors or the end-users was de facto a sale of a physical object containing an embedded programme and, therefore, those transactions were in the nature of sale of goods rather than licensing of copyright in software.
After much deliberation, the SC came to the conclusion that since the payment is for sale of software and such sale of software does not find a place in the definition of ‘Royalty’ under the Tax Treaty, the income of the foreign software vendors could not be regarded as royalties under the applicable tax treaties. Accordingly, the Court also upheld that the income was not taxable in India and there was no obligation on the Indian companies to deduct tax at source under 195 of the Act.
The three-judge bench of Justices RF Nariman, BR Gavai and Hrishikesh Roy dismissed the tax department’s appeal and allowed the appeal by the assessees. This victory will impact several companies who import software for sale in India. Tata Consultancy Services chose the long road to justice … and justice has finally been done.
(Ramadorai is former vice-chairman, Tata Consultancy Services, and Ostwal is on the UN Transfer Pricing Committee and is a senior chartered accountant)