DATE OF JUDGMENT: 2nd March, 2021.
JUDGES: R.F Nariman, Hemant Gupta and BR Gavai.
PARTIES : Engineering Analysis Centre of Excellence Private Limited (Plaintiff)
Commissioner of Income Tax (Respondent)
SUMMARY: The following judgment deals with the provisions of Sec. 195 of Income Tax Act, 1961, in addition to the provisions of Sec. 201 of the act, which deals with the consequences for defaults in the deduction and payment of TDS, in addition to various other provisions of the Income Tax Act.
OVERVIEW
1. The bench was hearing a batch of over 86 appeals which challenged the decisions of various High Courts holding that consideration paid for purchase of foreign software amounts to royalty.
2. The appellant in the present case is a resident Indian end-user of shrink-wrapped computer software, directly imported from the United States of America. The assessment years that we are concerned with are 2001-2002 and 2002-2003.
3. The Assessing Officer by an order dated 15.05.2002, after applying Article 12(3) of the Double Taxation Avoidance Agreement [“DTAA”], between India and USA, and upon applying Sec. 9(1)(vi) of the Income Tax Act, found that what was in fact transferred in the transaction between the parties was copyright which attracted the payment of royalty and thus, it was required that tax be deducted at source by the Indian importer and end-user, EAC. The appeal before the Commissioner of Income Tax [“CIT”] was dismissed by an order.
4. An appeal was made from the order of the ITAT to the High Court of Karnataka by the Revenue. High Court of Karnataka relied heavily upon the judgment of this Court in Transmission Corpn. of A.P. Ltd. v. CIT1 and held that since no application under section 195(2) of the Income Tax Act had been made, the resident Indian importers became liable to deduct tax at source, without more, under section 195(1) of the Income Tax Act.
5. This decision was later appealed in the Supreme Court along with various other decisions given in cases that dealt with the issue.
ISSUES
The following issues were analyzed by the Supreme Court:
- Whether or not the amount paid by Indian companies to use foreign software is taxable as royalty.
- Whether or not TDS can be deducted for purchase of software from foreign software suppliers.
IMPORTANT PROVISIONS
- Sec. 195 of Income Tax Act, 1961: TDS deductions on transactions/payments of Non-Resident Indians.
- Sec. 201 of Income Tax Act, 1961: Consequences for defaults in the deduction and payment of TDS.
- Sec. 9(1)(vi) of the Income Tax Act: Income by way of royalty.
ANALYSIS OF THE JUDGMENT
1. One group of appeals arises from a common judgment of the High Court of Karnataka, reported as CIT v. Samsung Electronics Co. Ltd.,2 by which the question which was posed before the High Court, was answered stating that the amounts paid by the concerned persons resident in India to non-resident, foreign software suppliers, amounted to royalty and as this was so, the same constituted taxable income deemed to accrue in India under section 9(1)(vi) of the Income Tax Act, 1961, thereby making it incumbent upon all such persons to deduct tax at source and pay such tax deductible at source under section 195 of the Income Tax Act.
2. The counsel for the appellants appearing in the case of M/s IBM India Ltd. v. Commissioner of Income Tax,3 submitted that his client is a nonexclusive distributor, which purchases off-the-shelf copies of shrink-wrapped computer software from a foreign company in Singapore for onward sale to Indian end-users under a Remarketer Agreement. He stressed that IBM India, the distributor, is not party to the EULA between IBM Singapore and the ultimate end-users/customers in India. the Indian end-user pays IBM India, and in turn, IBM India pays this amount to IBM Singapore after deducting a portion of profit.
3. He relied upon the judgment in Union of India v. Azadi Bachao Andolan,4 to argue that by virtue of section 90(2) of the Income Tax Act, the DTAA would prevail over domestic law to the extent it is more beneficial to the deductor of tax under section 195 of the Income Tax Act. According to him, even assuming that under section 9(1)(vi) of the Income Tax Act IBM India’s transaction would entail parting with copyright and attract royalty, upon applying the more beneficial provisions of the India-Singapore DTAA, it would be made clear that the amounts payable were not in the nature of royalty, and no income in the hands of the foreign supplier would be deemed to accrue in India.
4. He concluded by stating that no tax had to be deducted by the Indian importer under section 195(1) of the Income Tax Act.
5. The counsel for the respondents urged the court to rely on the decision given in the case of CIT v. Samsung Electronics Co. Ltd.,5 which held that what was sold/licensed by way of computer software, included the grant of a right or interest in copyright, and thus gave rise to the payment of royalty, which then required the deduction of TDS.
6. The court, on hearing both sides of the case, held that 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 the End-User License Agreements/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 (resident Indian importers) referred to in Section 195 of the Income Tax Act were not liable to deduct any TDS under Section 195 of the Income Tax Act.
CONCLUSION
This case deals with two situations which are related to each other. The first one being whether or not payment to foreign companies by Indian companies to use foreign software can be charged as royalty. The second issue being whether or not TDS can be deducted for purchase of software from foreign software suppliers.
The court has ruled that software firms have now been exempted from deducting TDS for purchase of software from foreign software suppliers. The ruling will lower the cost of software purchases for Indian firms as the overseas sellers may choose to lower prices, taking advantage of the tax relief. This ruling is said to greatly benefit software firms. While citing the definition of royalties contained in Article 12 of the double taxation avoidance agreements (DTAAs), the Supreme Court clarified 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.”
As far as chargeability of royalty in payment to foreign firms to use their software by Indian firms is concerned, the court held that payment for using foreign software did not amount to royalty which is taxable in India. The court held that the amounts paid by resident Indian end-users/distributors to non-resident computer software manufacturers/suppliers, 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.
However, taxpayers have opposed this view taken by the court, arguing that non-resident owner retains the proprietary rights in the software and the use of the software by the Indian company is limited to making backup copy and redistribution.
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