Amounts Paid By Indian Companies To Use Foreign Software Not 'Royalty';Not Income Taxable In India; No TDS Liability : Supreme Court

Settling an important issue in the income tax law, the Supreme Court on Tuesday held that the amounts paid by Indian companies for the use of softwares developed by foreign companies do not amount to 'royalty' and that such payment do not give rise to income which is taxable in India.

Therefore, there is no liability for Indian companies to deduct tax at source with respect to purchase of software from foreign companies.

"..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 EULAs/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 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", the court held.

A bench comprising Justices R F Nariman, Hemant Gupta and BR Gavai rejected the argument of the Income Tax Department that the purchase of software is taxable as income arising out of India.

The Court held that here 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. Therefore, the consequences of Section 201 of the Income Tax Act will not fall on the resident companies for not deducting TDS from foreign software companies.

The bench was hearing a batch of over 86 appeals which challenged the decisions of various High Courts holding that consideration paid for purchase of foreign software amounts to 'royalty'.

No copyright over softwares given; so payment for user-license agreement does not amount to royalty

The Court noted that the End User License Agreements (EULA) of the softwares do not transfer or assign the copyright over the software. What is granted to the distributor is only a non-exclusive, non-transferable licence 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.

The judgment used the following illustration to explain the point :

"If an English publisher sells 2000 copies of a particular book to an Indian distributor, who then resells the same at a profit, no copyright in the aforesaid book is transferred to the Indian distributor, either by way of licence or otherwise, inasmuch as the Indian distributor only makes a profit on the sale of each book. Importantly, there is no right in the Indian distributor to reproduce the aforesaid book and then sell copies of the same. On the other hand, if an English publisher were to sell the same book to an Indian publisher, this time with the right to reproduce and make copies of the aforesaid book with the permission of the author, it can be said that copyright in the book has been transferred by way of licence or otherwise, and what the Indian publisher will pay for, is the right to reproduce the book, which can then be characterised as royalty for the exclusive right to reproduce the book in the territory mentioned by the licence".

Sale of goods

The Court said that the transaction is akin to a sale of goods as held by the SC in the case Tata Consultancy Services v. State of A.P., 2005 (1) SCC 308.

"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, is in fact the sale of a physical object which contains an embedded computer programme, and is therefore, a sale of goods, which, as has been correctly pointed out by the learned counsel for the assessees, is the law declared by this Court in the context of a sales tax statute in Tata Consultancy Services v. State of A.P., 2005 (1) SCC 308", the judgment observed.

Double Taxation Avoidance Agreement to apply

The Court noted that the terms of Double Taxation Avoidance Agreement(DTAA) with foreign companies will have application in the case. The definition of 'royalty' in DTAAs will have application.Once a DTAA applies, the provisions of the Income Tax Act can only apply to the extent that they are more beneficial to the assessee and not otherwise.Where any term is defined in a DTAA, the definition contained in the DTAA is to be looked at. It is only where there is no such definition that the definition in the Income Tax Act can then be applied.

"Given the definition of royalties contained in Article 12 of the DTAAs mentioned in paragraph 41 of this judgment, it is clear 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. 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", the top court said in the 226-page judgment.

Non-Resident liable to TDS only if liable to pay tax in India

The Court observed that a non-resident Indian entity is liable to TDS only if is liable to pay tax under the charging provision contained in section 9 read with section 4 of the Income Tax Act, read with the DTAA.

"...it is only when the non-resident is liable to pay income tax in India on income deemed to arise in India and no deduction of TDS is made under section 195(1) of the Income Tax Act, or such person has, after applying section 195(2) of the Income Tax Act, not deducted such proportion of tax as is required, that the consequences of a failure to deduct and pay, reflected in section 201 of the Income Tax Act, follow", the judgment said.

To this extent, the judgment clarified the SC precedent in PILCOM v CIT West Bengal case(2020). The Court said that the PILCOM judgment was rendered in the context of Section 194E of the Income Tax Act, which dealt with liabilities of sportspersons, and that the same has no application in the instant case.

High Court judgment overruled

In 2011, the Karnataka High Court had held that payment made to foreign company amounted to 'royalty' and therefore the Indian purchaser had an obligation to deduct tax at source under Section 195 of the Income Tax Act(Commissioner of Income Tax and another v Samsung Electronics Co Ltd). In this case, a High Court division bench of Justices VG Sabhahit and Ravi Malimath reversed the judgment of Income Tax Appellate Tribunal which had held that amounts paid to foreign software suppliers was not 'royalty' and that the same did not give rise to any income taxable in India.

Following this decision, many cases were decided against Indian software companies, by holding them liable for TDS payment with respect to license fee given for use of foreign software.

The Supreme Court has set aside the judgment of the Karnataka High Court, mentioned above, and has approved the view taken by the Delhi High Court.

Four category of cases

The Supreme Court dealt with four category of cases :

1. The first category deals with cases in which computer software is purchased directly by anend-user, resident in India, from a foreign, non-resident supplier or manufacture
2. The second category of cases deals with resident Indian companies that act as distributors or resellers, by purchasing computer software from foreign, non-resident suppliers or manufacturers and then reselling the same to resident Indian end-users.
3. The third category concerns cases wherein the distributor happens to be a foreign, non-resident vendor, who, after purchasing software from a foreign, non-resident seller, resells the same to resident Indian distributors or end-users
4. The fourth category includes cases wherein computer software is affixed onto hardware and is sold as an integrated unit/equipment by foreign, non-resident suppliers to resident Indian distributors or end-users.

The Court held that in none of the said four categories, the payments for using foreign software did not amount to 'royalty' which is taxable in India.

Senior Advocates Arvind P Datar, Ajay Vohra, Pratheesh Kapur, Percy Pardiwala, S Ganesh, Advocates Sachit Jolly, Kunal Verma appeared for the appellant companies.

Additional Solicitor General Balbir Singh appeared for the Income Tax Department.

Case Details

Case Title  : Engineering Analysis Centre for Excellence Private Ltd vs The Commissioner of Income Tax

Coram : Justices RF Nariman, Hemant Gupta, BR Gavai

Citation : LL 2021 SC 124

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