No TDS required on import of shrink-wrapped software: Supreme Court


2021-03-02 16:25:20

MUMBAI: The Supreme Court (SC) on Tuesday ruled that payments made by resident Indian end-users or distributors (such as technology companies) to overseas suppliers on import of ‘shrink-wrapped’ software – generally known as off-the-shelf software, is not a ‘Royalty’ payment. Thus, no withholding tax obligations arise in India, against such payment.
During assessment and at various levels of judicial appeals, payments made for import of shrink-wrapped software to overseas suppliers was held assessable to tax as ‘Royalty’ under section 9(1)(vi) of the I-T Act and Article 12 of the respective tax treaties. This classification as ‘Royalty’ required tax to be deducted at source (TDS) when making payment to the overseas suppliers.
As TDS obligations were not met, the Indian distributors were held to be ‘assessees in default’ – heavy tax demands, which included penalties were raised on them. Now, they will be able to file for refund, which according to industry observers could run into several lakhs.
Over several days in February, the apex court heard a batch of more than 80 appeals, covering this issue of ‘Royalty’ payment. The companies involved in this prolonged litigation that lasted nearly twenty years, included Samsung Electronics, IBM India, Sonata Information Technology, Infineon Technologies, GE India Technology Centre, to name a few.
In short, the contention of the companies was that the use of software by the Indian importer was limited to making a backup copy and/or redistribution. They did not have the right to modify the shrink-wrapped software that was imported.
So, the payment made to the overseas supplier could not be treated as ‘Royalty’ but could only be treated as business income in the hands of the overseas entity and no tax withholding obligations arose. Today, in an order spanning 226 pages, the Supreme Court had upheld this stand and has set aside high court judgements that had held otherwise.
For instance, in 2011, the Karnataka high court in the case of Samsung Electronics had held that payment made for purchase of shrink-wrapped or off-the-shelf software was in the nature of ‘Royalty’. It had turned down the contention of the company that on purchase of shrink-wrapped software, it only acquired a ‘copyrighted article’ but not the ‘copyright’ itself, hence the amount paid was not assessable as ‘Royalty’. According to the Karnataka high court, when the software was redistributed the incorporated program was licensed to the end-user, hence the payments were held to be ‘Royalty’. This judgement is now set aside.
Hitesh Gajaria, senior partner at KPMG India states, “This welcome judgement puts at rest the widespread litigation on this contentious issue and gives relief to Indian companies who were being pursued by the I-T department for alleged non-withholding of Income-tax on payments made for purchasing computer software from non-residents.”
“Even as a new Equalisation Levy on non-resident e-commerce operators selling goods and services has come into force with mind-bogglingly vast scope and coverage, thankfully here the burden has been cast on those overseas companies to comply with the provisions of this new levy,” adds Gajaria.
Rakesh Nangia, chairman, Nangia Andersen India states, “The apex court today put a happy end to the twenty years old software-royalty tax dispute, by ruling in favour of the taxpayers, stating that cross-border payments made for sale of software to a non-resident is not be taxed as ‘Royalty’. It was a much-awaited order and will put to rest open litigation on this issue.”
Glimpses of submissions before the Supreme Court:
The SC heard these batch of appeals for several days in February. It observed that the appeals could be grouped in four categories. The first category deals with cases in which computer software is purchased directly by an end-user, resident in India, from a foreign, non-resident supplier or manufacturer. The second category of cases deals with resident Indian companies that act as distributors or resellers, by purchasing computer software from foreign, non-resident suppliers or manufacturers and then reselling the same to resident Indian end-users. The third category concerns cases wherein the distributor happens to be a foreign, non-resident vendor, who, after purchasing software from a foreign, non-resident seller, resells the same to resident Indian distributors or end-users. The fourth category includes cases wherein computer software is affixed onto hardware and is sold as an integrated unit/equipment.
The three-judge bench comprising of Justice R.F. Nariman, Justice Hemant Gupta and Justice B.R. Gavai held, “The amounts paid by resident Indian end-users/distributors to non-resident computer software manufacturers/suppliers, as consideration for the resale/use of the computer software through EULAs/distribution agreements, is not the payment of royalty for the use of copyright in the computer software, and that the same does not give rise to any income taxable in India, as a result of which the persons referred to in section 195 of the Income Tax Act were not liable to deduct any TDS under section 195 of the I-T Act. The answer to this question will apply to all four categories of cases enumerated by us…”
The parties that had filed the appeal before the SC were represented by well- known stalwarts. For instance, Arvind Datar, senior advocate who appeared on behalf of IBM India contended that earlier the apex court in the case of TCS had held that packaged software constituted ‘goods’. IBM India was a non-exclusive distributor of shrink-wrapped computer software. It did not own any right, title or interest in copyright and other intellectual property owned by IBM Singapore, and merely marketed IBM Singapore’s software products in India. It did not pay any consideration for the transfer of or interest in the copyright, thus such payments could not be categorised as ‘Royalty’ was his argument.
S. Ganesh, senior advocate, who appeared on behalf of Sonata Information Technology submitted that the provisions of section 52(1)(aa) of the Copyright Act 1957, gives the buyers of computer programs the right to make a copy if: It is done to utilise the computer program for the purpose for which it was supplied, or it is done to make backup copies for emergencies. The right to make a copy in order to use the software, does not imply that a ‘copyright’ has been assigned.
While the Finance Act, 2012, amended the I-T Act to widen the applicability of the Royalty provisions, most transactions in dispute were covered by the narrower definition provided in tax treaties. However, submissions were also placed that this retrospective amendment cannot apply to the cases being heard by the SC.
Ajay Vohra, senior advocate appearing on behalf of Sasken Communications Tech submitted that the retrospective amendment to section 9(1)(vi) of the I-T Act by adding Explanation 4, could not be applied as the assessment years of the matters being heard by the SC were prior to 2012. He emphasised that “…the law cannot compel one to do the impossible, namely, to deduct tax at source on an expanded definition of royalty which did not exist at the time of the payment/deduction to be made under section 195 of the I-T Act.”



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