Supreme Court dismisses Income Tax Department's appeal

Supreme Court dismisses Income Tax Department's appeal

Apex Court ruled that payments received by non-residents as consideration for the sale of computer software license to Indian companies are not taxable as royalty

The Supreme Court has set aside a Karnataka High Court verdict while allowing appeals filed by the assesses saying payments received by non-residents as consideration for the sale of computer software license to Indian companies is not taxable as royalty under the Income Tax Act.

An Apex Court bench of Justices Rohinton Nariman, Hemant Gupta and BR Gavai on 2 March 2021 examined in details what constitutes royalty and ruled that money paid by resident Indian end-users/distributors to non-resident computer software manufacturers or suppliers, as consideration for the resale or use of the computer software through End User License Agreements/distribution agreements, is not the payment of royalty for the use of copyright in the computer software.

The bench held that such payments do not give rise to any income taxable in India and the buyers of software are not liable to deduct any tax at source.

The IT department had contended that the Indian entities to whom the software license was granted should deduct tax at source before making payment to the foreign seller.

The Income Tax department's contention was challenged by the Indian entities saying that income thus generated cannot be classified as royalty but only as business income since the transaction between the foreigner seller and Indian companies is in the nature of the sale and not licensing.

The Top Court believed that there is no obligation on the persons mentioned in section 195 of the Income Tax Act to deduct tax at source as "the distribution agreements/EULAs in the facts of these cases do not create any interest or right in such distributors/end-users, which would amount to the use of or right to use any copyright."

The Karnataka High Court had earlier said that what was sold by way of computer software included a right or interest in copyright, which thus gave rise to the payment of royalty and would be an income deemed to accrue in India under section 9(1)(vi) of the Income Tax Act, requiring the deduction of tax at source.

The Supreme Court addressed this by adverting to the meaning of copyright with respect to computer software as provided in section 14(b)(ii) of the Copyright Act, 1957.

The bench said that the object of section 14(b)(ii) of the Copyright Act, in the context of a computer program, is to interdict reproduction of the said computer programme and consequent transfer of the reproduced computer.

The bench further opined that the section would only apply to the making of copies of the computer program and then selling them.

"Once it is understood that the object of section 14(b)(ii) of the Copyright Act is not to interdict the sale of computer software that is 'licensed' to be sold by a distributor, but that it is to prevent copies of computer software once sold being reproduced and then transferred by way of sale or otherwise, it becomes clear that any sale by the author of a computer software to a distributor for onward sale to an end-user, cannot possibly be hit by the said provision," the Apex Court ruled.

The bench clarified that when a distributor purchases computer software in material form and resells it to an end-user then cannot be said to be within the scope of section 14(b)(ii) of the Copyright Act.

"The sale or commercial rental spoken of in section 14(b)(ii) of the Copyright Act is of 'any copy of a computer programme', making it clear that the section would only apply to the making of copies of the computer program and then selling them, i.e., reproduction of the same for sale or commercial rental," it was held.

Mere distribution of copyrighted computer software will not constitute the grant of an interest in copyright under section 14(b)(ii) of the Copyright Act necessitating the deduction of tax at source under section 195 of the Income Tax Act, the Supreme Court concluded.