India’s long-standing controversy surrounding taxation of software payments has now effectively attained finality, with the Supreme Court dismissing the Revenue’s review petitions against its landmark ruling in Engineering Analysis Centre of Excellence Pvt. Ltd. v. CIT [(2021) 432 ITR 471 (SC)] wherein, the Supreme Court held that payments for off-the-shelf, shrink-wrapped or downloadable software do not constitute ‘royalty’ under the Income-tax Act, 1961 (“IT Act”) or applicable Double Taxation Avoidance Agreements (“DTAAs”) where no copyright rights are transferred.
Facts
The dispute arose in the context of payments made by Indian distributors and end-users to foreign software suppliers for the purchase, resale and use of standard software products. The tax authorities contended that such payments amounted to consideration for the use of copyright and therefore constituted “royalty” taxable in India, triggering withholding tax obligations under Section 195 of the IT Act.
Issues before the Supreme Court
- Whether payments made for purchase, resale or use of off-the-shelf/shrink-wrapped software constitute “royalty” under Section 9(1)(vi) of the IT Act and applicable DTAAs?
- Whether distribution and end-user arrangements involving standard software result in transfer of copyright rights or merely transfer/use of copyrighted articles?
- Whether such payments attract withholding tax obligations under Section 195 of the IT Act?
Discussion & Ruling
- The Supreme Court held that payments for standard software do not amount to “royalty” where the transaction merely grants the right to use a copyrighted article without transferring any copyright itself
- The Supreme Court distinguished between transfer of copyright itself and transfer/use of a copyrighted article, observing that end-users and distributors merely obtain a limited right to use the software
- The Supreme Court observed that the End User Licence Agreements and distribution agreements only imposed restrictions on use/resale of software and did not create any interest or rights in the underlying copyright
- The Supreme Court further held that amendments introduced under the IT Act through the Finance Act, 2012 could not be read into DTAAs in absence of corresponding amendments to treaty provisions
- Accordingly, the consideration paid for such software could not be characterised as royalty either under the IT Act or under the relevant DTAAs
- The Supreme Court also held that, in absence of royalty income chargeable to tax in India, such payments would not attract withholding tax obligations under Section 195 of the IT Act