- Hitherto, taxation of cross-border supply of software was a vexed issue on account of High Courts taking contrary views on the understanding / interpretation of the term 'copyright' under The Copyright Act, 1957 ("TCA 1957"). The underlying question was whether shrink-wrapped software being sold by non-residents to residents gives away the 'copyright' in the software or was it mere transfer of a 'copyrighted article'.
- Before the Supreme Court of India were a batch of appeals coming from matters decided by the High Court of Karnataka and that of the HC of Delhi.
- The High Court of Karnataka in the lead matter of Samsung Electronics Co. Ltd.1 held that what was sold / licensed by way of computer software included a grant of right or interest in a copyright and thus, the payment qualified as 'royalty' warranting withholding of tax at source at the time of remitting payment by a resident to a non-resident. Similar position was also adopted by the HC of Karnataka in the mater of Synopsis International2.
- Whereas a series of judgments3 by High Court of Delhi had held that in case of payments made towards purchase of software, no grant of right in or interest in a copyright is being transferred and thus, the payment does not qualify as 'royalty'. The Revenue was in appeal against the orders of the High Court of Delhi while the Taxpayer was in appeal against the orders of the HC of Karnataka before the Supreme Court of India.
- The Supreme Court of India in the lead matter of Engineering Analysis Centre of Excellence Private Limited v. CIT & Anr4, vide ruling dated 02 March 2021 (the 'Software Ruling'), held that upon perusal of facts and the specific provisions of The Copyright Act, 1957, the distribution agreement / End-User License Agreement (EULA), the payment did not create any interest or right in such distributor / end-users and would not amount to the use of or right to use of any copyright. Thus, the SC held that there is no obligation to withhold tax at source while making remittance for purchase of software on the premise that the nature of software does not qualify as 'royalty' as being taxable in India.
- The Software Ruling settles the principle of law as regards taxability of software payments in the hands of non-residents whilst reinforcing the withholding tax implications, i.e., that such obligation shall only be triggered when the payment is taxable in hands of the non-resident recipient.
- The Supreme Court of India, also, did not find merit in the argument that an Indian payer may not be able to rely on the provisions of the DTAA at the time of making the remittance as regards withholding tax is concerned. The Supreme Court of India distinguished the position held by the PILCOM ruling5 and held that a taxpayer is entitled to rely on the provisions of the DTAA while ascertaining its obligation to withhold tax while making remittances to a non-resident recipient.
- Another important observation from this decision can be made as regards India's reservation on the OECD Commentary. Before the Supreme Court of India, it was submitted that India has reserved / expressed contrary view as regards to principles of taxation of software payments. The Supreme Court of India disregarded such expression of reservation as impacting the tax position on the premise that a mere expression of reservation cannot be translated into the existing provisions of the DTAA. It observed and held that India had occasions to, and infact did, re-negotiated the DTAA with some country-partners and yet it did not make any changes to scope of what constitutes 'royalty'. Therefore, upholding the earlier principles as laid out in the decision of Azadi Bachao Andolan6, it dismissed the DTAA override argument. This principle, however, may have far-reaching implications insofar as any question that may arise on entitlement of DTAA benefits as regards taxation of indirect transfers7.
- While this ruling settles the dust as regards 'royalty', it may not necessarily ease the burden on taxpayer given that the amendment to Equalisation Levy provisions vide Finance Act, 2021 have created a carve out to cover within its ambit such transactions which are not in the nature of 'royalty'. Therefore, starting 01 April 2020 (interestingly, from a retrospective date), the non-resident recipient of such software payments may have to remit 2% of the gross transaction value as Equalisation Levy as opposed to the Indian payer having deduct tax at source at 10% (which was otherwise creditable).
- Now, with the controversy around the taxability of software payment atleast being settled in favour of the taxpayer, a question arises as regards what happens to cases where a non-resident recipient was subject to tax deduction at source ('TDS') and such taxes have not been claimed back as refund from the Indian tax authorities.
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1. CIT v. Samsung Electronics Co. Ltd., (2012) 345 ITR 494
2. CIT v. Synopsis International Old Ltd. ITA 11-15/2008
3. Director of Income Tax v. Ericsson A.B. (2012) 343 ITR 470, Director of Income Tax v. Nokia Networks OY, (2013) 358 ITR 259 and Director of Income Tax v. Infrasoft Ltd., (2014) 264 CTR 329
4. Civil Appeal Nos. 8733-8734 OF 2018
6. Appeal (civil) 8161-8162 of 2003 & Appeal (civil) 8163-8164 of 2003 - Supreme Court of India
7. Consider the finding of the AAR in the matter of 429 ITR 288 (AAR Ruling in the matter of Tiger Global International II Holdings, In re) in which it held that It is thus crystal clear that exemption from capital gains tax on sale of shares of company not resident in India was never intended under the original or the amended DTAA between India and Mauritius. This argument will almost entirely fail in light of the said observation of the Supreme Court of India.
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