Open source forsoftware taxation

Rajesh Patil Nisha Gopalani | Updated on April 21, 2013

Non-residents may have to live with uncertainty over the tax position that the retrospective amendment (on indirect transfer) has ushered in.

Finance Act 2012 introduced several retrospective amendments, purportedly ‘clarificatory’, to the Income-tax Act, 1961, with respect to non-resident taxpayers. A key amendment was the extension of ‘royalty’ to include payment toward shrink-wrapped software, connectivity charges, transponder hire charges and so on. Another significant amendment related to “indirect transfer” of capital assets located in India, thereby overcoming the Supreme Court decision in the case of Vodafone.

Finance Bill 2013 added to the burden by increasing the withholding tax on royalties payable to non-residents from 10 per cent to 25 per cent (excluding surcharge and cess). Let’s look at some of the issues related to taxability of royalty and indirect transfer.


The Government with the intention of overturning judicial precedents favouring the taxpayer in the taxability of software and other telecommunication-related services retrospectively provided that transfer of all or any right to use a computer software, including licensing, would be treated as royalty irrespective of the transfer medium.

Another amendment added to the definition of royalty any consideration with respect to right/ property/ information irrespective of whether the recipient controls or uses it, or whether such right/ property/ information is located in India or outside. Further, the term ‘process’ in the royalty definition was amended to include transmission by satellite, cable, optic fibre and so on. In the area of software payments, dispute largely arises over whether such receipts are for “the use, or right to use a copyright”, and hence royalties.

The Supreme Court in the case of Tata Consultancy Services held that intellectual property becomes ‘goods’ once put on media in any form and marketed. Taxpayers used to argue that computer software (which has intellectual property embedded) if put on media is sale of copyrighted article (akin to sale of goods) and, hence, the amounts received are in the nature of business income not taxable in the absence of a permanent establishment/ business connection in India.

Many judicial precedents, including the Delhi Special Bench in the case of Motorola Inc and the Delhi High Court in the case of Ericsson, held that software loaded on hardware is an integral part of the system with no independent existence, and the payment for supply of such equipment cannot be treated as royalty.

These precedents provided the distinction between copyright and copyrighted article. However, in cases such as Gracemac Corporation, Sonata Information Technology and, more importantly, the Karnataka High Court in the case of Samsung, the right transferred was held as transfer of copyright and the payment taxed as royalty.

These diverse judicial precedents led to the amendment in the definition of royalty through insertion of explanations. Tax authorities also argued in certain cases that the retrospective amendment should apply even to the definition of royalty in the Double Taxation Avoidance Treaty (DTAA). However, to the relief of taxpayers, the Mumbai appellate tribunal in the case of B4U International Holdings Ltd and the Delhi High Court in the case of Nokia Networks OY held that the amendments cannot be read into the DTAA.

Indirect transfer

The Vodafone saga led to retrospective amendments related to the indirect transfer of capital assets situated in India. The amendment provided that situs of share or interest in a non-resident entity will be deemed to be situated in India if the share or interest substantially derives, directly or indirectly, its value from the assets located in India.

To restore investor confidence, Prime Minister Manmohan Singh constituted an expert committee under the chairmanship of Parthasarathi Shome to examine the applicability of retrospective amendments to indirect transfer of capital assets situated in India. The committee submitted its draft report on October 9, 2012.

The key recommendation was to apply the amendments prospectively and that retrospection, if accepted, should be in the rarest of rare cases, with adequate safeguards in the form of interest and penalty waiver. To allay taxpayer concerns, the committee discussed the various terms used in the income tax provisions related to indirect transfer. In addition, it recommended exemption for certain categories of small investors, investors in FII and so on.

The committee no doubt attempted to clear the air on indirect tax provisions but some issues remain unaddressed, including the practical difficulties in determining fair market value, cost of acquisition and so on. We will have to see how the Government acts on the recommendations.


In view of divergent court rulings on taxability of software payments, a standard treatment cannot be adopted, as every judicial precedent is based on its own facts. The Shome Committee’s suggestion on clarifying the applicability of indirect transfer provisions in certain cases is welcome.

Finance Bill 2013 is silent on the recommendations, although it indicates acceptance of some recommendations related to the General Anti Avoidance Rules (GAAR). Non-resident taxpayers still have no clarity on the tax position this retrospective amendment has ushered in.

Rajesh Patil is Senior Manager and Nisha Gopalani is Deputy Manager at Deloitte Haskins & Sells

Published on April 21, 2013

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