The cloud of taxation software as royalty

A recent Supreme Court decision solved a decades-old problem with software taxation. Justice has been a long time coming, but justice has been done.

Patience and perseverance are certainly paying off and one of these striking examples is the recent decision of the Supreme Court of India (SC) which ruled in a 20-year-old software royalty case in favour of software companies, including Tata Consultancy Services. The taxation of income in the hands of a non-resident seller of standard copies of retractable film software in cross-border transactions has been a contentious issue for three decades. The main problem was that when the payment of the purchase of software was made to a non-resident seller, it was treated by the tax authorities as a “fee” or a “business income” in the hands of the seller.

The SC panel received a batch of 86 appeals on 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 an integrated hardware unit by non-resident suppliers to Indian distributors or end-users.

Initially, the CS reviewed distribution agreements between some of the Indian companies and foreign software publishers. After further examination, the Court noted that what these agreements conferred on Indian companies was merely a non-exclusive and non-transferable license of computer software. No copyright was granted on the software to Indian companies and even Indian end-users had no right to sublencie, transfer, reverse engineering, modify or reproduce the software other than what is permitted in the end-user licensing agreements (‘CLUF’).

The Court referred to section 14 of the Copyright Act, which makes it clear that copyright is an exclusive right to perform or authorize the conduct of certain acts relating to a work (which includes literary work and hence software).

A transfer of copyright would only take place when the owner of the copyrighted parties has the right to perform 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 separate rights, the first involving a transfer of copyright.

The use of the term “licence” in a CLUF / distribution agreement with the imposition of restrictive conditions on the use of the product, cannot be construed as a license under article 30 to perform the acts listed in section 14 of the Copyright Act, thereby annuling the Karnataka High Court (supra) maintaining that that licence was in line with the definition of copyright. In light of the above decision, the CS held that, without a doubt, what foreign sellers had “conceded” to Indian distributors or end-users was the de facto sale of a physical object containing an integrated program and, therefore, those transactions. were the nature of the sale of property rather than the licensing of software copyrights.

After much deliberation, the CS concluded that, since the payment is for the sale of software and such a software sale does not find its place in the definition of “royalty” under the tax treaty, the revenues of foreign software publishers cannot be considered royalties under the applicable tax treaties. Accordingly, the Court also confirmed that income was not taxable in India and that Indian companies were not required to deduct tax at source under section 195 of the Act.

The three-judge panel of Judges RF Nariman, BR Gavai and Hrishikesh Roy dismissed the tax department’s appeal and allowed the appeal of the individuals assessed. This victory will impact several companies that import software for sale in India. Tata Consultancy Services has chosen the long road to justice… and justice is finally done.

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