Tax alert

India clarifies tax controversy regarding the applicability of withholding on sale of software

May 11, 2022
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Technology industry Business tax International tax

In a landmark judgment, the Supreme Court of India, in the context of a tax dispute concerning the role and rights of an Indian distributor with respect to a foreign software owner, has opined that:

  • Distribution of software to distributor/end user will not constitute grant of an interest in copyright in the software as the distribution agreement only grants a non-exclusive, non-transferable license to resell computer software; 
  • Right to reproduce and the right to use computer software are distinct and separate rights and in case of non-exclusive end user license agreement, no rights are transferred; and
  • Income earned under such agreements is business income and does not give rise to any taxable income absent a Permanent Establishment in India and accordingly no liability for withholding tax arises.

The controversy arose from the fact that the Indian income tax department treats such payments made to non-residents for software purchase as a ‘royalty’, and therefore subject to withholding tax when payment is made to a non-resident recipient.

On the other hand, the non-resident manufacturer/distributors argued that the transaction between the foreign software company and Indian end-user/distributor is a ‘sale’ and not grant of ‘license’.

The Supreme Court decision has provided clarity to a controversy that has impacted businesses for over 20 years by upholding the taxpayers’ contention that these transactions are simple ‘sales’ of software and do not entail ‘licensing’ of any copyright which would have attracted royalty payments under the Indian Income Tax Act.

Businesses impacted by this ruling should review their particular facts and consider whether filing a refund claim (plus interest) for taxes that were withheld under what is now an erroneous presumption is appropriate considering the cost-benefit of the refund process. 

The attached Newsflash from RSM India provides additional insight into the controversy, issues involved and the basis for the Supreme Court’s decision.

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