Cross-border payment for software not royalty, SC ends two-decade old tax dispute

The Supreme Court has put an end to an over two-decade-old software royalty tax dispute after it ruled that cross-border payments made for the sale of software to a non-resident are not to be taxed as "royalty".

The court in its order on Tuesday said that given the definition of royalties contained in the Double Taxation Avoidance Agreement (DTAA), it is clear that there is no obligation on a person to deduct tax at source, as the end-user licence agreements in these cases do not create any interest or right in such end-users, which would amount to the use of or right to use any copyright.

The Supreme Court stated 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 end-user agreements or 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.

Tax experts hailed the SC order, saying the judgment would have a far-reaching impact. Rakesh Nangia, Chairman, Nangia Andersen India, says the ruling was much awaited and will put to rest open litigation on this issue. "The ruling will have a far-reaching impact as it now becomes the law of the land. This issue has been quite convoluted and remained an apple-of-discord for multiple years," he says.

Also read: I-T dept extends deadline for filing declarations under VsV scheme till March 31

Vishal Malhotra, National Tax Leader - TMT, EY India, said the judgement not only brings certainty to 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."

The contentious issue of royalty tax on the use of software emanated from the fact that the income tax department treats the payments made to non-residents for software purchase as royalty.

The department has argued that when the software is sold, the incorporated program is licenced to the end-user. According to tax authorities, the Indian entity is granted the rights to exploit the intellectual property or copyright in the software and consequently, the payment for such purchases amounts to royalty income for the seller.

However, taxpayers have contended that these transactions are simple sales and do not entail licencing 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.

Therefore, it has argued that payment received for the 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.

This issue was contested before various courts in the past. The two most important and conflicting rulings were in the case of Samsung Electronics where the Karnataka High Court had ruled in favour of the Revenue and Delhi High Court's ruling in the case of Ericsson favouring the taxpayers.

Also read: Tax disputes worth Rs 97,000 crore under new amnesty scheme