Sale of Software Licenses not Constitute Royalty
The topic, “Sale of Software Licenses do not constitute Royalty”, by taking a case law on which the Honourable Supreme Court of India made or delivered a landmark decision on 2nd of March 2021. The facts of the case along with the conclusion has been given below:
Facts of the Cases
There was a lot or a batch of 103 appeals with the court which were pending for taking a decision on the issue. And this was either filed by the revenue department or taxpayers as a result of divergent decisions made by the respective High Court. The disagreement which was lying here was regarding the taxation of the software payments which was to be made as royalty or income from business income in the hands of the non-resident taxpayers.
The court for convenience divided the available cases into four major categories and this was made on the basis of the agreements which were made between the supplier or licensor of software and the distributors and also the final consumers or the users. The four categories into which the Supreme Court divided the cases were:
The court ruled that the copyright licenses in any manner are not purchases, and this gives the literal sense of understanding that the software payments would be considered and accounted to a sale of goods.
The court also ruled that copyright licenses shall not be considered as purchases, and this means that the software payments would be considered as the sale of goods.
The honourable Supreme Court of the country India issued a landmark ruling on the date of March 2 2021. And this was made in the case pertaining to the Engineering Analysis Centre of Excellence Private Limited. This particular verdict paved the way for settling a long-running controversial issue which was existing over how payments made the by Indian customers to non-resident suppliers for the use or reselling of computer-based software should be typified, providing much-required taxcertainty on such anissue.
Facts of the cases
There was a lot or a batch of 103 appeals with the court which were pending for taking a decision on the issue. And this was either filed by the revenue department or taxpayers as a result of divergent decisions made by the respective High Court.The disagreement which was lying here was regarding 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 was 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 the end-users, and
- Computer based software which is sold along with the hardware by a seller or supplier who is a non-resident to the distributors or the end-users who are residents or residing in India.
The Revenue Department was upon the ground that the payments which are made for these software’s are royalties under the Income Tax Act and also the Double Taxation Avoidance Agreements (DTAA), on the basis that these transactions involved the transfer of copyright. But the taxpayers are on the contention that this payment should be treated as business income and not royalty.
The Honourable Supreme Court while making decisions on these cases and issues majorly considered the provisions of the following Acts namely:
– the Copyright Act 1957 (Copyright Act),
– the Income Tax Act, 1961 (ITA),
– and the relevant DTAAs.
The Court held that the amount which is paid by Indian end-users or the 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).
The court on the basis of analysing the samples of distributor agreements and EULAs jotted the following:
– The distributor gets only a non-transferable and a 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,
– The consumer can use the computer program by itself, but there shall not be any further permission or right provided to sub-license or reverse-engineer or transfer or, modify, reproduce in any manner otherwise than permitted by the license to such consumer,
– The distributor pays the computer program’s price as a good, in a medium that either store the software or embeds it in the hardware,
– The right to use the product is not given to the distributor, and
– The computer program can be used by the end-user by installing it in the computer hardware owned by him and cannot in any manner reproduce it for being sold or for being supplied or transferred.
Now let us understand what is copyright as it is important to ensure if any of the transfer or sale of the software in the cases before the Court constitutes the transfer of copyright as per the Copyright Act. And as per this Act, copyright can be understood as an exclusive right that restricts others from doing certain acts. It is an intangible asset that is coming actually in the nature of a privilege. There is no material substance attached with the same. It should also be noted that owning copyright and owning a physical material in which such copyright work is embodied is different.
Section 14 of the Copyright Act is providing that, a copyright is an exclusive right which permits one to do or provide the authority to do of certain acts pertaining to a work, which is including the literary work also. And the computer programs would be grouped as literary work 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 with the right to do any of the acts mentioned in section 14, and 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 of supplying or giving of the commercial rental or offering for a dealer providing the commercial rental any copy of the computer software or program.
The seven acts include the following:
- To replicate the work in any of a material format, which would also include the storing of the same in an electronic medium or format;
- To issue copies of the work to the public, provided they are not copying 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 of 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 do with the translation of the work, any of the acts prescribed or that was specified in relation to the work in sub-clauses (i) to (vi).
Now coming to 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. And explanation 2 to section 9(1)(vi) is providing the meaning of ‘royalty’ 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.
And the scope of royalty was increased by explanation 4 to section 9(1)(vi) by stating that transfer of all or any rights includes moving of all or any right for use or right to make use of a 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 only 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 which were put before the court connected with the taxation of the payments that were made to non-residents by both the end-users and distributors, royalty was held as not being taxable as royalties by the authority.