The Supreme Court held that the amounts paid by Indian companies for the use of softwares developed by foreign companies do not amount to 'royalty.'
Also, such payments do not give rise to income which is taxable in India.
What does this mean?
The SC has followed the globally-accepted interpretation.
Accordingly, payment made by end-users and distributors is akin to payment for sale of goods.
It is not for grant of licence under the Indian Copyright Act.
So, the buyer only gets the right of use, and not the intellectual property of the software.
Only where copyright in the software is permitted to be exploited by the payer can the payment take the character of royalty.
Indian companies thus need not deduct tax for the amount they pay to foreign manufacturers and suppliers for use or re-sale of computer software through end-user licence agreements (EULA).
This ruling should now prevent similar disputes, but a few questions still require deliberation.
What are the unaddressed issues / challenges?
Refunds - Both Indian payers (importers) and non-resident sellers must evaluate the impact of the ruling on pending disputes.
The underlying issue has been put to rest.
So now, the taxpayers will be looking to obtain refunds of taxes paid against demands raised or taxes paid by way of withholding tax deposited.
In cases where this aspect has not been disputed in the past, fresh claims for refunds will have to be lodged.
This will be either by the non-resident payee or resident payer depending on the type of contracts.
Thus, review of the contracts for software supplies is necessary to determine eligibility for refunds and lodge claims.
For refund claims barred by the statute of limitations, taxpayers may need to approach the Central Board of Direct Taxes for directions for grant of refund.
Foreign tax credits - Another impact is on the foreign tax credits (FTC) claimed by non-resident sellers in their home-country against the taxes paid or withheld in India.
Such non-residents will have to ascertain the right quantum of FTC credit claimed in their home-country.
They will then have to evaluate the risk of reversal or reduction of claim.
TDS - There are many resident payers who adopted a non-taxability position at the withholding stage.
But given the different stance of the tax laws, demands were raised/tax recovered from the purported failure to withhold tax at source.
In such cases, the payers may have recovered back-taxes from the non-resident payees, invoking tax indemnification clauses under the contract.
Such non-resident payees may now seek a refund from the payers.
How will the ruling benefit?
The ruling brings much-needed certainty on characterisation of software transactions.
This is especially true for non-resident taxpayers facing the ire of the retrospective amendments.
The rationale laid down by the apex court will be relevant for all pending cross-border tax disputes.
However, the non-resident taxpayers will have to ensure that they meet the eligibility for treaty entitlement such as beneficial ownership and evidence of a valid tax residency.
Given the stakes involved, it is certain that the government treasury has to pay a few hundred crore in refunds.
The ruling, however, provides clarity in interpreting tax laws applicable to cross-border transactions and reassuring taxpayers.
