The taxability of payments by importers for software imports from non-resident suppliers is a vexed question on which courts had earlier given conflicted rulings. The question has now been settled by the Supreme Court in the recent cases grouped under the title of Engineering Analysis Centre of Excellence Private Limited v Commissioner of Income Tax and Anor.
The cases related to the import from non-resident suppliers of software in four categories:
- where software was purchased directly by end-users;
- where distributors purchased software from non-resident suppliers and resold it to end-users;
- where non-resident distributors purchased software from non-resident sellers and sold it to distributors or end-users, and
- where software was installed on hardware sold by non-resident suppliers to Indian distributors or users.
The question was whether the consideration paid to non-resident suppliers was a royalty, requiring tax to be withheld by Indian importers.
Tax law allows residents of countries with which India has a double tax avoidance agreement (tax treaty) option to be taxed under Indian law or under the treaty law. Under the treaty law, business income of non-residents can be taxed in India only if they have a permanent establishment (PE) in India. However, royalties paid to non-residents can be taxed in India even if they have no PE. In the present case none of the non-resident suppliers had a PE in India. Therefore, the question was whether amounts paid by importers to non-resident suppliers were royalties.
A royalty is defined in tax treaties as the consideration for the right to use any copyright of a literary, artistic or scientific work in connection with any patent, trademark, design, plan or secret formula. The revenue considered that the import of software was a transfer of copyright, and therefore payment for it was a royalty, requiring the withholding of tax. It cited provisions of the Copyright Act under which the copyright owner has the right to reproduce the work and issue, sell or rent the copies. It argued that, as the import of software included a licence to use it, the consideration paid was a royalty.
The taxpayers submitted that they were non-exclusive distributors who purchased off-the-shelf copies of the software from non-resident suppliers for sale to Indian end-users under remarketer agreements (RA). The end-users’ licence agreements (EULA) were between the non-resident suppliers and end-users. The RAs gave the importers no rights in the copyright owned by the suppliers. The transfer of copyright in an original work is different from the transfer of a copyrighted article. The EULAs gave end-users only a limited licence to use the software without any right to sub-licence or make copies. The payments to non-resident suppliers were not royalties, but the proceeds of the sale of goods.
The court held as follows:
- the liability to withhold tax arises only if the amounts remitted to the non-resident suppliers are chargeable to tax in India;
- the provisions of tax treaties prevail over those of domestic law. Therefore, the definition of a royalty in the tax treaty must be considered;
- a computer program is defined in the Copyright Act as a set of instructions in words or codes to cause a computer to perform a particular task;
- copyright is the exclusive right to do or authorise the doing of certain acts in respect of a work, including the right to copy or modify it;
- when the copyright owner assigns a right in the copyright for consideration, the assignee becomes the owner of only the assigned rights;
- the RAs show that the distributors were granted only non-exclusive, non-transferable licences to resell the software. No other right was granted to the distributors or end-users. End-users were granted the mere right to use the software without any rights to copy or modify it;
- there is a difference between the right to reproduce or modify software and the mere right to use it, and
- the consideration paid by importers is for the right to resell the software in India.
The court held that the consideration paid by importers to non-resident suppliers for the resale or use of computer software was not payment of royalties. It was for the purchase of copyrighted articles, in other words, a business expenditure. There was thus no liability on importers to withhold tax.
SHAHID KHAN is a senior partner at Kochhar & Co. Lakshay Goyal, an associate, assisted with the article
New Delhi (head office): Kochhar & Co. Suite # 1120 -21, 11th Floor, Tower – A, DLF Towers, Jasola District Center, Jasola – 110 025, India
India offices: New Delhi, Mumbai, Bengaluru, Chennai, Gurugram and Hyderabad
Overseas offices: Dubai, Singapore,
Chicago and Jeddah
Tel: +91 11 4111 5222,
+91 11 4312 9300