The issue of taxability of payments for standard off-the-shelf software (shrink wrapped software) and consequent withholding tax implications on the same has been a contentious issue for a long time now. The issue has assumed interest in the recent past in light of conflicting rulings at various fora.
Typically, in case of standard software, the software package would be imported physically or downloaded through internet. Physically, the package would be in a CD and would have a licence attached to it. In case of internet download the licence is accessed through a Web site and downloaded by the user. In either case, the licence is provided more to protect the rights of the owner of software, though which the owner grants a right to use the software to a user for a price. A typical shrink wrapped software licence specifically prohibits any modification, re-engineering, etc.. It also generally provides that all intellectual property rights in the software are retained by the supplier/owner. The licence permits copying of the software in the hard disk of the user for use and back-up.
Globally, the ownership/intellectual property right in software is governed by copyright laws.
The controversy is whether the consideration paid for purchase of such standard software from overseas suppliers is taxable in India or not. The view of the Revenue Department is that the payments made for purchase of standard software tantamount to royalty and accordingly taxable in India. On the contrary, the position of taxpayers is that the purchase of standard software is akin to purchase of goods and, therefore, should not be taxed as royalty.
What is royalty?
Generally, royalty includes within its ambit payments of any kind received as a consideration for the use of, or the right to use, any copyright of a literary, an artistic or a scientific work. This definition is interpreted by taxpayers to mean that royalty arises only in cases where payment is made for usage of the intellectual property right in the software. In view of the same, the argument put forth by taxpayers is that in case of standard software, the purchaser does not get any right in the ‘copyright' of the software and consequentially the payment is merely for purchase of ‘copyrighted article' and hence not subject to tax as royalty. This view is also advocated in the commentary by renowned authors and principles according to the international tax laws.
The position of the Revenue Department is that a licence to use the software tantamount to granting of licences for the use of the copyright in the software constituting royalty. The Tribunals in many cases (Sonata, Samsung, General Electric, Hewlett-Packard, etc.) have held in favour of the taxpayer. The Karnataka High Court in the case of Samsung and others overruled the Tribunal decisions and held the payments to be in the nature of royalty.
The Court's primary reason was that the right available to the purchaser to make a copy for back-up purposes would not have been available in absence of the licence and, therefore, the licence obtained is for the use of copyright. The Court did not concur with the contention of the taxpayer that the underlying rights available to a copyright holder are not passed in the case of a standard software and hence the payment should not be characterised as royalty. The Court did not consider the distinction between the payments for use of copyright and that for the use of a copyrighted article, which is a significant departure from the position laid down by Courts in some earlier decisions.
Divergent rulings
In contrast, the Delhi High Court in a recent case of Ericsson AB (delivered after the Karnataka High Court decision) has not concurred with the contention of the Revenue Department that a licence to use the software tantamount to usage of copyright and hence taxable as royalty. In this case the software was purchased as an integral part of the hardware.
The Delhi High Court held that where the software is integrated with the hardware and it merely facilitates the functioning of the hardware, the arrangement is for the contract for supply of goods and no part of the payment, therefore, can be classified as payment towards royalty. In laying down this proposition, the Court relied on the principle laid down by the Supreme Court in the case of Tata Consultancy Services, wherein the apex court had held that software which is incorporated in a medium should be treated as goods.
The issue of taxability of software is of paramount importance given that in today's technology-driven world, any organisation, big or small, use one or the other form of software. The ruling of the Karnataka High Court has a far-reaching impact for software companies given the high volume of software imports. Importers would endeavour to negotiate with software vendors and withhold tax on software imports. However, in most cases, the vendors are not too keen on deduction of tax considering the challenges in getting the foreign tax credit and other issues. Therefore, organisations in India have to bear additional costs.
Given the divergent rulings from Courts in States, the issue will be settled only at the Supreme Court where it is currently pending.
The controversy is whether the consideration paid for purchase of standard software from overseas suppliers is taxable in India or not.
(This article was published in the Business Line print edition dated January 30, 2012)
