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SC ruling backs taxpayers in software royalty case

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SC ruling backs taxpayers in software royalty case

  • The judgement will impact hundreds of firms that import software for sale in India

The Supreme Court on Tuesday ruled that payments made by an Indian resident to a foreign company for import of computer software for sale in India will not be assessed as “royalty".

The Supreme Court on Tuesday ruled that payments made by an Indian resident to a foreign company for import of computer software for sale in India will not be assessed as “royalty".

An SC bench, headed by Justice Rohinton F. Nariman, held that such offshore payments for software “will not give rise to any income taxable in India" and, therefore, no liability would accrue for the resident firms to deduct TDS under Section 195 of the Income Tax Act.

An SC bench, headed by Justice Rohinton F. Nariman, held that such offshore payments for software “will not give rise to any income taxable in India" and, therefore, no liability would accrue for the resident firms to deduct TDS under Section 195 of the Income Tax Act.

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The bench, which comprised Justices Hemant Gupta and B.R. Gavai, clarified that the ruling will apply to all instances of software purchases directly by an Indian end-user from a foreign supplier or manufacturer, when the resident Indian companies act as distributors or resellers for other residents; or when a foreign distributor resells to Indian users and the software is installed on the device by a foreign supplier for Indian residents.

The judgment, which involved approximately 500 crore in tax revenue, will impact companies like IBM India Ltd, Samsung Electronics Co. Ltd, Hewlett Packard India, Mphasis Ltd, Sonata Software Ltd and GE India.

It will also be relevant for over 100 firms that import software for sale in India since the payments made by them will now constitute “business income" in the hands of the recipient and in the absence of a permanent establishment of such recipient in India, no tax is required to be withheld at source.

The dispute began after the Karnataka high court in 2011 decided in favour of the tax department, holding that payments to non-resident firms for purchase of software should be treated as royalty, obligating the resident companies to deduct TDS at the time of credit of such sum or at the time of payment, whichever is earlier. However, other high courts and the income tax tribunal took divergent views, calling upon the SC to examine the question of law and settle it.

Before the top court, the tax department had contended that the sale of copyrighted software should constitute as a grant of an interest in their copyright under the Copyright Act, necessitating the deduction of tax at source.

The companies, on the other hand, emphasized that these transactions were in the nature of sale and no part of copyright was transacted since the non-resident continued to have proprietary rights in the software.

Accepting the companies’ submissions, the SC bench held that the amount paid by them to the foreign software suppliers did not amount to royalty, as a result of which, there was no liability to deduct TDS. It underlined that the sales did not attract the rigours of the Copyright Act because no right to reproduce was given to the resident firms and, hence, such payments could not come under the ambit of “royalty".

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