The topic, “Sale of Software Licenses does not constitute Royalty”, is based on a case law in which the Honourable Supreme Court of India made or delivered a landmark decision on 2arch 2021. The facts of the case, along with the conclusion, have been given below:
Facts of the Cases
There were 103 appeals with the Court pending a decision on the issue. These were either filed by the revenue department or taxpayers as a result of divergent choices made by the respective High Courts. The disagreement that was lying here was regarding the taxation of the software payments, which were to be made as royalty or income from business income in the hands of the non-resident taxpayers.
The Court for convenience divided the Court’s cases into four major categories, and this was made on the basis of the agreements between the supplier or licensor of software and the distributor, as well as the final consumers or users. The four categories into which the Supreme Court divided the cases were:
The Court ruled that copyright licenses are not licenses in manner, and this gives the literal sense of understanding that software payments would be considered and accounted for as a sale of goods.
The Court also ruled that Courtight licenses are not purchases; the Court means that software payments are considered the sale of goods.
The honourable Supreme Court of the country, India, issued a landmark ruling on March 2, 2021. This was made in the case of the Engineering Analysis Centre of Excellence Private Limited. This particular verdict paved the way for settling a long-running, controversial issue, which had been existing over how payments made by Indian customers to non-resident suppliers for the use or reselling of computer-based software should be taxed, providing much-needed tax certainty on this issue.
Facts of the cases
There were 103 appeals with the Court pending a decision on the issue. These were court cases filed by the revenue department or taxpayers as a result of divergent choices made by the respective High Courts. The disagreement that was lying here was whether the taxation of the software payments was to be made as royalty or income from business income in the hands of the non-resident taxpayers.
The Court then separated and typified the pending cases into four broad groups based on the agreements that were made between the supplier/licensor of software and distributors/end-users:
- Purchase of computer software that was made on a direct basis by a resident from a non-resident supplier or manufacturer,
- Purchase of software by a resident Indian company acting as a distributor or reseller and reselling to Indian end-users,
iii. Purchase of software, which was done by a non-resident distributor from a non-resident supplier, and reselling to Indian distributors or end-users, and
- Computer-based software is sold along with the hardware by a seller or supplier who is a non-resident to distributors or end-users who are residents or residing in India.
The Revenue Department argued that the payments made for this software are royalties under the Income Tax Act and the Double Taxation Avoidance Agreements (DTAA) because these transactions involved the transfer of copyright. However, the taxpayers contend that this payment should be treated as business income and not royalty.
The Honourable Supreme Court, while making decisions on these cases and issues, mainly considered the provisions of the following Acts, namely:
– the Copyright Act 1957 (Copyright Act),
– the Income Tax Act, 1961 (ITA),
– and the relevant DTAs.The Court held that the amount which is paid by Indian end-users or distributors to the non-resident supplier or manufacturer of software, for use or reselling the same through end-user license agreements (EULAs) or distribution agreements, cannot be classified or accounted as a royalty payment. And it also held that the persons or the non-resident citizens who are referred to in section 195 of the Income Tax Act are also not liable to withhold any tax out of such payments which are made to the other person or the supplier or manufacturer in the form of TDS (Tax Deducted at Source).
TCourt,urt on the basis of analysing the samples of distributor agreements and EULAs, jotted the following:
– The distributor gets only a non-transferable and non-exclusive license to resell computer software,
– No copyright in the computer program is transmitted to either the distributor or to the ultimate end-user,
Consumers can use the computer program themselves. Still, they shall not be given any further permission or right to sublicense, reverse engineer, transfer, modify, or reproduce in any manner other than permitted by the license to such consumer.
– The distributor pays the computer program’s price as a good, in a medium that either embeds the software in the hardware or embeds it in the hardware.
– The right to use the product is not given to the distributor, and
The end-user can use the computer program by installing it on their computer hardware, but they cannot reproduce it for sale, supply, or transfer.
Now let us understand whatcopyright is,t as it isessentialt to ensure if any of the transfer or sale of the software in the cases beforethe Courtt constitutes the transfer of copyright as per the Copyright Act. And as per this Act, coActight can be understood as an exclusive right that restricts others from doing certain acts. It is an intangible asset that is actually in the nature of a privilege. There is no material substance attached to the same. It should also be noted that owning copyright and owning a physical material in which such copyrighted work is embodied are different.
Section 14 of the Copyright Act provides that a copyright is an exclusive right that permits one to do or give the authority to do certain acts pertaining to a work, including literary works. Computer programs would be grouped as literary works as per the provisions of the Copyright Act.
The Copyright Act also states that a transfer of copyright would occur only when the owner of the copyright parts has the right to do any of the acts mentioned in section 14. As per section 14(b), this explicitly includes:
– The seven acts which are listed and enumerated under the sub-clause (a), and
– The eighth Act is the application or giving of the commercial rental or offering for a dealer to provide a copy of the computer software or program.
The seven acts include the following.
- To replicate the work in any of the material formats, which would also include storing it in an electronic medium or format.
- To issue copies of the work to the public, provided they are not copies already in circulation;
iii. To carry out the task in public, or converse and convey it to the public;
- For making a cinematographic film or even a sound recording with respect to the work;
- To make a conversion of the work;
- To make any alteration or another edition of the work; and
vii. To do, with respect to the translation of the work, any of the acts prescribed or specified in relation to the work in sub-clauses (i) to (vi).
Now, regarding the royalty and taxation of the same, we have to refer to section 9(1) (vi) of the Income Tax Act. The rule is majorly providing that the income if any to paid or payable by a resident of India, then the same shall be would be deemed to have accrued or arisen in India, on the occasion where the royalty payment was made with an object of earning any income from any source that is located or situated in India. Explanation 2 to section 9(1)(vi) provides the meaning ‘f ‘roya’ty’ as a consideration which would be paid for the moving or transferring of all or any rights (also including granting a license) in the value of any copyright.
The scope of royalty was increased by explanation 4 to section 9(1)(vi) by stating that the transfer of all or any rights includes the transfer of all or any right to use or to make use of computer software. The Court also held that once a DTAA applies to the case of the assessee, the provisions of the Income Tax Act can only apply to the extent they are more beneficial to the taxpayer. Hence, the Court said that by virtue of Article 12(3) of the DTAA, royalties are payments of any kind received as a consideration for the use of, or the right to use, any copyright, of a literary work, including a computer program or software.
Now on the ground that the end user is only getting the right to use computer software under a non-exclusive license, which again ensures that the owner continues to retain the ownership under section 14(b) of the Copyright Act read with sub-section 14(a) (i)-(vii), payments for computer software sold or licensed on a CD or other physical media cannot be classed as a royalty.
Thus, in all the cases that were put before the Court related to the taxation of payments made to Court distributors by both end-users and Court distributors, Courtlty was held not to be taxable as royalty by the authority.
