The Hindu Business Line : Another twist in the software tale

In the recent Airports Authority of India case, the AAR held that payment for licensed software would constitute royalty income, liable to tax in India under the I-T Act and the India-US Tax Treaty.

A new interpretation.

Sandeep Ladda
Milan Shah

With increasing globalisation, more and more Indian companies are acquiring, inter alia, software from overseas suppliers. Typically, software supply can be by way of licence of a copy of the software with end-use restrictions, or it can be supplied for further development and distribution after making copies.

Generally speaking, supply of a copyrighted article (example, copy of standard software such as Norton Anti-Virus), amounts to a sale of a mere product. In such a case, right to commercially exploit the work in the software, the source code to software, etc., (together referred to as right in the copyright) is not transferred to the end-user.

Accordingly, any payment for the former (that is, supply of a product), should ideally not be taxed as royalty as per the definition under the Income-Tax Act, 1961 and Tax Treaties. However, payment for use or right to use any right in the copyright would qualify as royalty.

Royalty income

Several rulings — the Tribunal rulings in the cases of Ericsson-Nokia-Motorola, Lucent Technologies, Samsung, Wipro, etc., and the Supreme Court’s decision in Tata Consultancy Services (though rendered in the context of Sales Tax Act) — have confirmed this general position.

However, in a recent ruling in the Airports Authority of India (assessee) case, the Authority for Advance Rulings (AAR) has taken a different stand, holding that payment for licensed software (that is, copyrighted article) would constitute royalty income, liable to tax in India under the I-T Act and the India-US Tax Treaty.

In this case, the assessee proposed to import a surveillance system consisting of hardware, licensed customised software and documentation inclusive of installation, testing and training services under an agreement with a US-based company. The customised software constituted 90 per cent of consideration. Subsequently, it approached the AAR for determining taxability of the transaction.

The assessee contended that transfer of title and risks in the system and entire activities under the agreement would be outside India. It also argued that the royalty-free licence to use customised software was granted on non-transferable and non-exclusive basis with restrictions on making copies for distribution to public and other end-use restrictions.

Relying on the Supreme Court ruling in Tata Consultancy, the airport authority argued that such software would qualify as goods. The assessee contended that as the essence of the agreement was an outright sale of hardware and software outside India, the transaction was not liable to tax in India.

Tax ruling

The AAR pronounced its decision separately on taxability of hardware, software and installation services. In respect of sale of hardware, the AAR characterised the payment as business income and held as not taxable in India in the absence of a permanent establishment (PE).

For licensed software, after analysing various clauses of the licence agreement, the AAR concluded that the assessee had no ownership in the copyright and was merely given right to use the same.

Hence, the payment for licensed software would constitute royalty income, liable to tax in India under the act and the treaty. The AAR rejected the assessee’s reliance on the OECD commentary in the context of software payments, which propounds the general position on software payments discussed earlier.

AAR clarification

While so concluding, the AAR distinguished the apex court decision in the Tata Consultancy case by observing that the legislative scheme and object of sales tax law and income-tax law are different and there is no provision with regard to royalty under the sales tax law. The AAR further held that the provisions of the I-T Act and the Treaty were clear and, therefore, reference to the Copyright Act or to any other source was not necessary. On provision of installation, testing and training services, theAAR held that such services rendered were technical in nature and hence constitutes fees for technical services, liable to tax in India under the Act and the Treaty.

Pertinently, the AAR has not discussed various favourable rulings on the subject. Thus, while the facts of each case need to be examined to ascertain the taxability of the software payment — and while the aforesaid AAR ruling has limited applicability i.e., it applies only to the assessee and only to the facts of the case — it appears that the said ruling shall not apply to transactions involving sale of copyrighted article.

(The authors are Associate Director and Manager, respectively, PricewaterhouseCoopers. blfeedback@thehindu.co.in)