Payment for import of software license does not qualify as Royalty – Supreme Court of India


published on 8 March 2021 | reading time approx. 3 minutes


The Supreme Court of India on March 02, 2021 settled the long pending issue of taxability of cross border payments for import of software licenses in favor of the Taxpayers.




The issue revolves around the taxability of cross-border payments for purchase of software licenses i.e., whether such payments qualify as royalties under the Indian domestic tax law read with the applicable DTAAs. While the taxpayers contended that payments for software licenses were for use of “copyrighted articles” which are akin to a sale of products and not for “use of copyrights” and therefore such payment does not qualify as royalties. The Indian Tax Authorities treated such payments as royalties primarily on the ground that the end-users had obtained the right to exploit the intangible rights in such software programs, as they inter-alia had received rights to make copies for back-up and storage of the software programs.  


In a number of different appeals, the Taxpayers got a favorable order from the Delhi High Court holding that payments for software licenses do not qualify a royalties. The Indian Tax Authorities on the other hand received confirmation on their stand from the Karnataka High Court holding that payments for software licenses would qualify as royalties. Consequently, the issue reached the Supreme Court for adjudication.


Decision of the Supreme Court

The Supreme Court sided with the Taxpayers. The Supreme Court held that in all the cases, the license which had been granted was not a ‘license’ that transfers an interest in all or any of the copyrights but is a ‘license’ to grant the use the copyrighted article. The Supreme Court held that for interpreting the term copyright under the Income Tax Act, a reference has to be made to the Indian Copyright Act. As per the Copyright Act, the owner of the copyright is given the right to inter alia reproduce a work, make copies, and for software to sell or rent out the software.


The appeals were clubbed into following four categories:

  1. A foreign entity (e.g. a software developer) selling a software license to an Indian customer for the customer's own use (end-use);
  2. An Indian entity purchasing software license (from a foreign entity) and re-selling (distributing) it to Indian customers;
  3. A foreign entity purchasing software license outside India and re-selling (distributing) it to Indian distributors or end customers;
  4. A foreign entity affixed the software into a product (hardware) and sells the integrated product to an Indian customer for its own use or for the purpose of resale


Characterization of Payments for Software Licenses

For each of the group of appeals, the Supreme Court analyzed the provisions of the Copyright Act (along with various amendments made therein) vis-à-vis the End User License Agreement or remarketing / distribution agreement. The Supreme Court found that in all the cases, the licensees had been given only a right to use or re-sell the software. In none of the cases the owner had parted with any of the rights as defined under the Indian Copyright Act. Inter alia the following terms and conditions of the license agreements were considered important:


For group 1, the end-use by the licensee:

  • the restriction to amend the software; and
  • the restriction to sublicense the software


For group 2, the resell by the licensee:

  • the restriction to assign any rights under this Agreement to any other person
  • the restriction to amend the software
  • the clarification that the licensee shall not own any rights, title or interest in the copyright


For group 3, the end-use or resell by the licensee:

  • the restriction to amend the software
  • the restriction to make copies
  • the clarification that the licensee shall not own any rights, title or interest in the copyright


For group 4, the purchase of goods with embedded software:

  • the restriction to make copies
  • the clarification that the licensee shall not own any rights, title or interest in the copyright


Under all agreements discussed, the Supreme Court noted that none of the agreements could be said to have granted the “use of copyright” under the Copyright Act. For example, a right to reproduce the software. The Supreme Court draws a comparison to an English publisher who sells 2000 copies of a book to an Indian distributor. In such a case, no copyright in the book would be said to be transferred to the Indian distributor. He would especially be barred from making and selling copies of the book. 


Widened Royalty Definition vis-à-vis Definition provided in Respective DTAAs

The Supreme Court then dealt with the attempt of the Indian lawmakers to decide the dispute about taxing software royalties in favor of the Indian state. Back in 2012, when various High Courts were already debating the matter, the Income Tax Act was amended to state that the transfer of a copyright shall have always deemed to have included the granting of a right to use a software thereby making such transaction taxable. An explanation was inserted in this regard which was made effective from 1976 onwards and was said to only mean a “clarification” of the law. The amendment was targeted at revoking the very basis of any adverse court decision. The Supreme Court now held such an attempt to be “ludicrous”. In 1976 software had hardly been known or even regulated by law. The Supreme Court accepted the Taxpayer’s argument that law cannot demand to do the impossible. Therefore, Indian licensees (payors) cannot be said to have been assesses in default for not having withheld taxes in the years before 2012 on payments of software license fees to foreign Taxpayers by not applying the widened royalty definition.


Further, the Supreme Court noted that provisions under a DTAA prevail over Indian domestic tax law (the Income-tax Act, 1961) where they are more beneficial to the Taxpayer. Importantly, the Supreme Court further held that the OECD Commentary to the OECD Model Convention will continue to have persuasive value although India is not a member of the OECD. The Supreme Court recognized correctly that the OECD does not regard licensing a right to use or resell a software to equally granting a right to use a copyright. What carries importance beyond this case is that the Supreme Court held India’s reservation to that part of the OECD commentary to be irrelevant. First, such a reservation would only mean that India may intend to enter into DTAAs which diverge from the OECD position but such DTAAs had not been concluded, yet. Further, the Supreme Court also stated that foreign Taxpayers “have a right to know exactly where they stand in respect of the treaty provisions that govern them […] and can thus place reliance on the OECD Commentary […]” at least in the absence of diverging or conflicting court decisions. Therefore, the Supreme Court did not apply the widened scope of royalties of the 2012 “clarification” to the cases now decided. The Taxpayers had been protected by their respective tax treaties.


Withholding of Tax on Payments for Software Licenses

The Supreme Court reiterated the principle enunciated by its earlier decision in the case of GE India Technology Centre (P) Ltd. (2010) 10 SCC 29 to hold that the obligation to withhold taxes under Indian domestic tax law would arise only when such income is chargeable to tax for the non-resident in India. Foreign Taxpayers thus are not bound to first accept a tax deduction by the licensee and proceed with a lengthy refund claim thereafter. Note, in order to convince the licensee not to deposit withholding tax from the license fee, the licensor has to provide (inter alia) a Tax Residency Certificate to the licensee together with his invoice. Only such certificate will enable the licensee to correctly decide about the taxability of the fee (by applying applicable DTAA provisions).


Our Comments

The Supreme Court decision puts an end to the controversy on the issue of taxability of payments for software licenses to a non-resident. It certainly provides a much needed clarity for all the four categories of cases mentioned above. The reasoning of the Supreme Court decision in our opinion also applies to current day cases. Foreign Taxpayers who are protected by DTAAs similar to the OECD Model Convention may claim not to be governed by the widened scope of royalties under the 2012 “clarification”. Their income earned from granting a right to use (for its own purpose) or to distribute a software to an Indian resident would be exempt from Indian Income Tax.


While analysing the matter, the Supreme Court has done an in-depth analysis of the End User License Agreement/Distribution or Remarketing Agreement vis-à-vis the provision of the Indian Copyright Act. It is therefore important to review the agreement to check whether principles enunciated by  the Supreme Court applies to one’s case.


Foreign Taxpayers who charge a consideration for software licenses need to be aware that they are still required to file an Income Tax Return in India declaring their income. Such income will be shown as “exempt income” under the DTAA provisions in the Income Tax Return. The Indian Tax Authorities may proceed to verify the treaty entitlement of the foreign Taxpayer. Such requirement only has a technical character to ensure that fair protection under the DTAA is claimed by the Taxpayer.

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