The Supreme Court ruled Tuesday that the amounts paid by Indian companies for the use of software developed by foreign companies did not constitute “royalties” and that these payments did not generate income that is taxable in India.
Therefore, there is no obligation for Indian companies to deduct withholding taxes when purchasing software from foreign companies.
“..the amounts paid by resident Indian end-users / vendors to non-resident computer software manufacturers / suppliers in return for reselling / using the computer software through EULAs / distribution agreements are not royalty payments for the use of copyright in the computer software and that this does not result in any taxable income in India that did not require persons referred to in Section 195 of the Income Tax Act to deduct TDS from Section 195 of the Income Tax Act, “the court ruled.
A bank made up of Judges RF Nariman, Hemant Gupta and BR Gavai rejected the Income Tax Department’s argument that purchasing software as income from India was taxable.
The Court ruled that there is no obligation here for the persons referred to in Section 195 of the Income Tax Act to withhold taxes as the Distribution Agreements / EULAs in the facts of these cases do not create an interest or right in such distributors / users who would be equivalent to the use or the right to use a copyright. Therefore, the consequences of Section 201 EStG will not fall on resident companies if they do not deduct TDS from foreign software companies.
The bank heard a number of over 86 appeals contesting the rulings of various high courts that the consideration paid for the purchase of foreign software was a “license fee”.
No copyright given for software; So paying for a user license agreement doesn’t mean a license fee
The Court found that the end-user license agreements (EULA) for the software do not transfer or confer copyright in the software. The distributor is only granted a non-exclusive, non-transferable license to resell computer software, whereby it is expressly stated that neither the distributor nor the end user is granted a copyright in the computer program.
“In all of these instances, the” license “granted by the EULA is not a license within the meaning of Section 30 of the Copyright Act that has an interest in all or some of the provisions set out in Sections 14 (a) and 14 (b) of the Copyright Act, but is a “license” that imposes restrictions or conditions on the use of computer software, so it cannot be said that any of the EULAs we deal with refer to Section 30 of the Copyright Act, insofar as Section 30 of the Copyright Act speaks of granting an interest in any of the rights set forth in Sections 14 (a) and 14 (b) of the Copyright Act, “stated Justice RF Nariman’s judgment.
The judgment used the following illustration to explain the point:
“If an English publisher sells 2,000 copies of a particular book to an Indian distributor who then resells it for a profit, the copyright in the above book is not transferred, by license or otherwise, to the Indian distributor, provided that the Indian distributor obtains it only make a profit with the sale of each book. The important thing is that the Indian distributor has no right to reproduce the above book and then sell copies of the same. On the other hand, if an English publisher would sell the same book to an Indian publisher, this time with the right to reproduce and copy the aforementioned book with the permission of the author, it can be said that the copyright to the book was transferred by license or otherwise and what the Indian publisher pays for the right to reproduce the book, which then as a license fee for the exclusive right to reproduce the book in the by the area named in the license. “
Sale of goods
The Court found that the transaction was equivalent to a sale of goods as held by the SC in Tata Consultancy Services v State of AP, 2005 (1) SCC 308.
“What is” licensed “from the overseas non-resident supplier to the distributor and resold to the resident end-user or supplied directly to the resident end-user is in fact the sale of a physical object that contains an embedded computer program, and is therefore a Selling goods which, as the learned attorney has correctly pointed out for the appraisers, is the law declared by that court under a sales tax law in Tata Consultancy Services v State of AP, 2005 (1) SCC 308, “the judgment observed.
Double taxation treaties apply
The Court found that the provisions of the Double Taxation Avoidance Agreement (DTAA) with foreign companies will apply in this case. The definition of “license fees” in DTAAs applies. As soon as a DTAA applies, the provisions of the Income Tax Act can only apply to the extent that they are more advantageous for the beneficiary and not otherwise. Where a term is defined in a DTAA, the definition contained in the DTAA must be considered. Only if there is no such definition can the definition in the Income Tax Act be applied.
“Given the definition of royalties in Article 12 of the DTAAs mentioned in paragraph 41 of this judgment, it is clear that the persons named in Section 195 of the Income Tax Act are not required to deduct the withholding tax as a distribution. Agreements / EULAs in the facts of these cases do not create any interest or Right to such distributors / end users, which would amount to the use or the right to use a copyright. The provisions of the Income Tax Act (Section 9 (1) (vi) along with Notes 2 and 4) dealing with royalties and for the examiners are not more advantageous, no application to the facts of these cases, “said the Supreme Court in the 226-page ruling.
Non-TDS Non-Resident Individuals Taxable in India
The Court found that a non-resident Indian entity is subject to TDS only if it is taxable under the tax provision contained in Section 9 in conjunction with Section 4 of the Income Tax Act in conjunction with the DTAA.
“… it is only if the Indian non-resident is required to pay income tax on income believed to be incurred in India and there is no deduction of TDS under Section 195 (1) of the Income Tax Act or has any such person after application of § 195 Abs. 2 EStG the required tax portion is not deducted, so that the consequences of a failure of the deduction and the payment according to § 201 StGB follow “, so the judgment said.
In this respect, the judgment clarified the SC precedent in the PILCOM v CIT West Bengalen case (2020). The Court found that the PILCOM judgment was given in relation to Section 194E of the Income Tax Act, which dealt with the liabilities of athletes, and that the same does not apply in the present case.
High Court judgment overturned
In 2011, the Karnataka Supreme Court ruled that the payment made to a foreign company was a royalty and therefore the Indian buyer was required to deduct the withholding tax under Section 195 of the Income Tax Act (Commissioner of Income Tax and another v. Samsung) Electronics Co Ltd). In this case, a division bank of the High Court of Judges VG Sabhahit and Ravi Malimath overturned the Income Tax Appellate Tribunal’s ruling, which found that amounts paid to foreign software suppliers were not royalty and that they did not generate income taxable in India.
Following this ruling, many cases have been resolved against Indian software companies holding them liable for TDS payment related to the license fee for the use of foreign software.
The Supreme Court overturned the aforementioned Karnataka Supreme Court ruling and endorsed the Delhi Supreme Court’s view.
Four categories of cases
The Supreme Court dealt with four categories of cases:
- The first category addresses cases where computer software is purchased directly by an India-based end-user from a foreign, non-resident supplier or manufacturer
- The second category of cases concerns Indian resident companies who act as distributors or resellers by purchasing computer software from overseas non-resident suppliers or manufacturers and then reselling it to Indian resident end-users.
- The third category concerns cases where the reseller happens to be a foreign non-resident vendor who, after purchasing software from a foreign, non-resident seller, resells it to resident Indian resellers or end users
- The fourth category includes cases where computer software is installed on hardware and sold by foreign, non-resident suppliers as an integrated unit / equipment to resident Indian distributors or end users.
The court ruled that in none of the four categories mentioned did the payments for the use of foreign software not constitute a “license fee” which is taxable in India.
Leading lawyers Arvind P. Datar, Ajay Vohra, Pratheesh Kapur, Percy Pardiwala, S. Ganesh, and lawyers Sachit Jolly and Kunal Verma appeared on behalf of the applicants.
Additional Attorney General Balbir Singh appeared for the Income Tax Department.
Case Title: Engineering Analysis Center for Excellence Private Ltd v Commissioner of Income Tax
Coram: Judges RF Nariman, Hemant Gupta, BR Gavai
Quote: LL 2021 SC 124
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