In a landmark judgment, the Supreme Court of India, in the context of a tax dispute concerning the role and rights of an Indian distributor vis-à-vis foreign software owner, has opined that:
Distribution of software to distributor/end user will not constitute grant of an interest in copyright in it; and
It only grants a non-exclusive, non-transferable licence to resell computer software.
The tax department sought to classify such a sale under ‘royalty’ payable on account of software sale to resident/s by non-resident companies.
The companies involved in this prolonged litigation included Samsung Electronics, IBM India, Sonata Information Technology, Infineon Technologies and GE India Technology Center.
The tax department argued that when the software is sold, the incorporated program is licenced to the end-user. According to the tax authorities, the Indian entity is granted the rights to exploit the IP or copyright in the software. Consequently, the payment for such purchases is tantamount to royalty income for the seller.
Hence, the department contended that the Indian entities were licencees of the software and should have deducted tax at source (TDS) before making payment to the foreign company.
On the other hand, Indian entities acting as a distributor of software companies had opposed this contention. The Indian entities argued that the transaction between the foreign software company and Indian entities is ‘sale’ and not ‘license’.
Court ruling
The Supreme Court concluded that:
· The amount paid by the resident Indian software user either as end-users or distributors of non-resident computer software manufacturers or suppliers, for the resale or use of the computer software through end-user license agreements (EULA)/distribution agreements, is not royalty payment for the use of the copyright in the computer software;
· Such a transaction does not give rise to any income taxable in India considering the distribution agreements/EULAs in the facts of the case/s do not create any interest or right in such distributors/end-users; and
· No copyright in the computer program is transferred either to the distributor or to the software's ultimate end-user.
Therefore, the income generated in foreign companies' hands cannot be classified as ‘royalty’ which is paid on grant of a license/s. It can only be classified as business income which would obviate the need for deducting any TDS in this transaction and thus pay tax on it.
The Supreme Court, in its ruling, also looked into the meaning of copyright with respect to computer software as provided in Section 14(b)(ii) of the Copyright Act, 1957.
The object of this section in the context of a computer program is to prohibit reproduction of the said computer program and the consequent transfer of the reproduced computer.
The Supreme Court opined this section (of the Copyright Act) would only apply to making copies of the computer program and then selling them, i.e. reproduction of the same for sale or commercial rental.
In other words, Section 14(b)(ii) of the Copyright Act makes it clear that it is the exclusive right of the owner to sell or to give on commercial rental or offer for sale or for commercial rental "any copy of the computer program".
A distributor who purchases computer software in material form and resells it to an end-user cannot be said to be granted rights that fall within the scope of Section 14(b)(ii) of the Copyright Act. Therefore, the distribution of copyrighted computer software will not constitute a grant of an interest in copyright under Section 14(b)(ii) of the Copyright Act.
The Supreme Court concluded that there are no necessitating circumstances created for treating it as business income, resulting in tax deduction at source under Section 195 of the Income Tax Act.
Conclusion
The contentious issue emanated from the fact that the income tax department treats such payments made to non-residents for software purchase as ‘royalty’.
The Apex Court decision has put an end to a long debate vindicating the non-taxability stand on software payments. The Supreme Court upheld the taxpayers’ contention that these transactions are simple sales and do not entail licencing of any copyright which would have attracted royalty payments under the Income Tax Act.
The judgment will impact hundreds of transactions involving foreign software companies dealing with Indian entities that import software for sale in India.
Ranjan Narula
Managing partner, RNA, Technology and IP Attorneys
Rajiv Suri
Partner, RNA, Technology and IP Attorneys
