Indian companies that use foreign software have no TDS liability, and it would not amount to Royalty: SC

On Tuesday, the Supreme Court settled an important income tax law. It ruled that the amount paid by Indian companies for using software developed by foreign companies cannot be termed ‘royalty’, and it would not amount to income that is taxable in India.

In short. Indian companies are not liable to deduct tax at source regarding the purchase of software from foreign companies.

The Bench rejected the Income-tax Department’s argument that the purchase of software is taxable as it is an income that arises out of India.

Hon’ble Court clarified that people are not obligated to deduct tax at source as distribution agreements/ EULAs in present cases don’t create interest or right for end-users or distributors, which would amount to the use of copyright.

Therefore, the consequences/penalty mentioned u/s 201 of the Income Tax Act would not fall for Indian companies that don’t deduct TDS from foreign software companies.

The Bench opined that End User License Agreements of software do not assign or transfer the software copyright. The distributor only gets a non-transferable, non-exclusive license to resell the software, and it’s clear that the end-user or the distributor does not get copyrights.

Hon’ble Court further opined that the transaction is akin to the sale of good and relied on Tata Consultancy Services vs State of AP wherein the Apex Court held that what is licenced by a company/software firm is the sale of a physical object that contains an embedded computer code and is therefore similar to a sale of goods.

According to the Bench, Double Taxation Avoidance Agreement with foreign companies will have application in the case. Once DTAA comes into effect, the Income Tax Act would only apply in a way that is beneficial to the assessee. 

The Bench noted that a non-resident Indian company is liable for TDS only if they have to pay tax under Section 9 r/w Section 4 of the Income Tax Act r/w Double Taxation Avoidance Agreement.

By rendering this judgement, the supreme court has set aside Karnataka High Court’s judgement in Commissioner of Income Tax, and another vs Samsung Electronics Co Ltd wherein the Court held that payment to software companies amounts to ‘royalty’, and therefore software companies have to deduct TDS.

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