No Royalty, No TDS

Inclusion of Software Payments In The Definition of ‘Royalties’?

Excellence Private Limited Vs. The Commissioner of Income Tax & Anr

Civil Appeal Nos. 8733 – 8734 OF 2018 Dated 03 .03. 2021

I. Important Definitions

1) In India, “software” has been defined under the Income Tax Act, 1961 and the Copyright Act, 1957.

a) Sections 10A, 10B, and 80HHE of the ITA, dealing with export of computer software defines “computer software” to mean –

i) any computer programme recorded on any disc, tape, perforated media, or other information storage device; or

ii) any customized electronic data or any product or service of similar nature as may be notified by the Central Board of Direct Taxes, India.

2) Section 2(ffc) of the Indian Copyright Act, 1957 defines “Computer Programme” as a set of instructions expressed in words, codes, schemes, or any other form, including a machine-readable medium, capable of causing a computer to perform a particular task or achieve a particular result. Thus, software necessarily connotes a “programme” in relation to a computer.

Related Topic:
Article on Royalty Part-II

II. What’s the issue?

1. There have been a lot of ambiguities have arisen regarding the payment made to a non-resident entity for the grant of the use of computer software by a businessman in India for internal business purposes.

2. The Income Tax Department has been treating such payments as royalty and accordingly, bringing the same to tax in India.

3. On the other hand, the assessees who make use of such computer software, have been taking a stand that the aforesaid payment is of the nature of business profits and therefore, the same would not be liable to tax in India, because of the provisions of Article 7 of the Double Taxation Avoidance Agreement (DTAA), entered into between India and several foreign countries.

4. In this connection, the assessees have been taking a stand that the scope of the definition of royalty under section 9(1)(vi) is quite wide, whereas the scope of the definition of royalty under Article 12(3) of the DTAA is restrictive.

5. In this connection, it may also be stated that the Delhi High Court has been adopting a very firm view that the amount received by the assessee under the license agreement for allowing the use of the software is not royalty, because what is transferred is neither the copyright in the software nor the use of the copyright in the software, but what is transferred is the right to use the copyrighted material or article, which is distinct from the rights in a copyright.

6. The Madras High Court has also followed the aforesaid view adopted by the Delhi High Court.

7. However, the Karnataka High Court has adopted an erroneous view in this regard, (in the case of Samsung Electronics Co. Ltd)

Before we proceed to deal with the aforesaid issues in detail, it may be necessary to understand: –

a. The meanings of the terms “Royalty” and “Business profit” and the difference between the two.

b. Characterization of cross-border software payments or payments concerning the import of technical services, as either royalty or business profits or some other head, has always been a contentious issue in India. The underlying point of the question involved herein is that whether such a transaction would amount to a “transfer of a copyright” or “transfer of a copyrighted article”.

III. History of taxation

1. The applicable rate of taxation on royalty and FTS has always been a matter of debate because of the high difference in rates under the DTAAs and Income Tax Act, 1961.

2. Before 2013, as per Section 115A of the Income Tax Act, 1961, taxation on royalty and FTS was 10 percent on a gross basis.

3. However, the rate was amended by Finance Act, 2013, to 25 percent on a gross basis.

4. Again, the Government of India vide Finance Act, 2015, reverted to the previously applicable rate of 10 percent.

5. The aforesaid rates are exclusive of applicable surcharge and educational cess.

6. However, as per Section 206AA of the Income Tax Act, 1961 (applicable since 1st April 2010), there is a mandatory requirement of furnishing PAN even by a nonresident.

7. In case non-residents do not possess PAN, a higher rate of withholding tax of 20 percent against payments to non-residents would be applicable. Lastly, royalties and fees for technical services accruing or arising to a foreign company (which has a permanent establishment in India) have been excluded from chargeability of Minimum Alternate Tax (MAT) if the tax payable on such income is less than 18.5% (exclusive of surcharge, education cess, etc.).

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