India’s Supreme Court settles dispute on royalty tax withholding in India

Mar 12, 2021

With regard to an over two-decade-old software royalty tax dispute, India’s Supreme Court (“SC”) has ruled that software payments made by Indian end-users or distributors and resellers to overseas software suppliers are payments for sales and not for royalties. Therefore, such payments are not subject to withholding tax in India unless the non-resident seller has a permanent establishment in India. You can find the discussed SC judgement here.


With the exponential growth of the information technology sector in India, there have been increasing instances of Indian companies acquiring software from foreign companies. Broadly speaking, transactions in relation to computer software fall under any one of the following categories:

  1. Where computer software is purchased directly by an end-user Indian resident from a foreign supplier or manufacturer.
  2. Where Indian companies who are distributors or resellers purchase computer software from foreign suppliers or manufacturers and then resell to Indian resident end-users.
  3. Where foreign vendors purchase software from a foreign seller and resell to Indian resident distributors or end-users.
  4. Where computer software is affixed onto hardware and is sold as an integrated unit/equipment by a foreign supplier to Indian resident distributors or end-users.

Under the provisions of the Income-tax Act, 1961 (the “IT Act”), the term “software” has been defined to mean: (i) a computer programme recorded on any disc, tape, perforated media or other information storage device; or (ii) any customised electronic data or any product or service of similar nature as may be notified by the Central Board of Direct Taxes.

Under the Indian Copyright Act, 1957, the term “computer programme” has been defined to mean 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 “programme” in relation to a computer.

Under Explanation 2 to section 9(1)(vi) of the IT Act, the term “royalty” is defined as the consideration (including lump sum payment) for the transfer of all or any rights (including the granting of a license) in respect of a patent, invention, model, design, secret formula, process, trademark, copyright, literary, artistic or scientific work.

The two-decade-old controversy

The controversy on taxability of cross-border software payments relates to the characterisation of income in the hands of the non-resident and whether the payment received by a non-resident for providing a licence to use computer software is chargeable to tax as royalty or sale of goods.

The lower level Indian tax authorities (the “ITA”) have regarded such sales as generating royalty income by arguing that in such sale transactions, the computer programme embedded in the software is also licensed or parted with to the end-user of the software. On the other hand, the software companies have rebutted this position on the grounds that: (i) although the definition of the term “royalty” under section 9(1)(vi) of the IT Act is wide, the scope of the definition of the term “royalty” under Article 12(3) of various tax treaties is restrictive; and (ii) the sale transaction is a transfer of a “copyrighted article” and not a transfer of the right in the copyright or licence of the software. Therefore, the consideration received by the non-resident software companies should be treated as business income not chargeable to tax, in the absence of a permanent establishment in India.

Key points in the SC ruling

After examining eighty-six appeals, the SC held that:

  1. A copyright is an exclusive right, which is negative in nature, and it restricts others from doing certain acts.
  2. A copyright is an intangible, incorporeal right, and a privilege, which is quite independent of any material substance. Ownership of copyright in a work is different from the ownership of the physical material in which the copyrighted work may happen to be embodied. An obvious example is the purchaser of a book or a CD/DVD, who becomes the owner of the physical article, but does not become the owner of the copyright inherent in the work.
  3. What is granted to the distributor is only a non-exclusive, non-transferable licence to resell computer software, with no copyright in the computer programme being transferred either to the distributor or to the ultimate end-user.
  4. Apart from a right to use the computer programme by the end-user himself, there is no further right to sub-license or transfer, nor is there any right to reverse-engineer, modify, or reproduce in any manner.
  5. What is paid by way of consideration by the distributor in India to the foreign, non-resident manufacturer or supplier is the price of the computer programme as goods, either in a medium which stores the software or in a medium by which software is embedded in hardware, which may then be further resold by the distributor to the end-user in India for a profit. Importantly, the distributor does not get the right to use the product at all.
  6. When it comes to an end-user who is directly sold the computer programme, such end-user can only use it by installing it in the computer hardware owned by the end-user and cannot in any manner reproduce it for sale or transfer.
  7. What is “licensed” by the foreign, non-resident supplier to the distributor and resold to the resident end-user, or directly supplied to the resident end-user, is, in fact, the sale of a physical object which contains an embedded computer program, and is, therefore, a sale of goods. This is similar to the SC’s ruling on what constitutes a “sale of goods” in the Tata Consultancy Services case.
  8. Once a tax treaty provision applies, the provisions of the IT Act can only apply to the extent they are more beneficial to a taxpayer and not otherwise. Where any term is defined in a tax treaty, the definition contained in that tax treaty must be looked at.
  9. Given the definition of royalties in Article 12 of the tax treaties, there is no obligation on the Indian residents to withhold tax at the source. If the consideration paid is for the purchase of a product and not for the transfer of the intellectual property per se, it should not be regarded as royalty.

Our Comments

The SC’s ruling has finally put the controversial issue of tax on payments made for purchasing software to rest by deciding it in favour of the taxpayer. The ruling reaffirms the withholding tax obligation rules laid down by the SC in the Azadi Bachao and GE Technology cases. Further, the commentary on the OECD Model Conventions has been given considerable importance in holding that to constitute “royalty” under international tax treaties, there needs to be licensing along with rights to exploit the copyright in the software.

This verdict will come as a huge relief for companies such as Samsung, Nokia, Ericsson, IBM, Hewlett Packard, Mphasis, Sonata, GE and others who import software for sale in India.

About the Author

Ravi S. RaghavanRavi S. Raghavan has more than 25 years of experience in corporate tax advisory work, business re-organizations, international taxation (investment and fund structuring, repatriation strategies, treaty analysis, advance rulings, exchange control regulations, FPI taxation), tax litigation services, and other tax issues (including withholding taxes, capital gains tax, permanent establishment concerns, employee taxation, and tax holiday schemes).

Ravi has spoken at different forums on various tax matters, including at the Annual India Tax Forum in New Delhi, and at the Annual Symposium on India’s Taxation Regime at the National Law School of India University, Bangalore

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