There is an ongoing debate if the sale/transfer of computer software attracts Income Tax in India or not. Accordingly, where foreign company transfers computer software to an Indian company from outside India, a question arises as to whether the Indian company is liable to deduct tax at source while making remittance from India. The problem is complex because the software is generally embedded with intellectual property rights. In other words, the acquirer of the software usually also gets along with the software a licence to use the same.
The Income Tax department argues that purchase of software and payment therefore amounts to royalty payment in consideration for getting a licence to use the software. The other view is that the supply of software should be treated as sale of goods. The Supreme Court in case of Tata Consultancy Services vs. Union of India 271 ITR 401 has held that supply of software should be treated as sale of goods liable for levy of sales tax.
The problem arises because the Indian Income Tax Act does not contain any clear provision with regard to transfer of computer software. In fact there are two types of software, namely, “Unbranded software which is specialised and exclusively custom made to cater to the needs of individual clients” and “Branded software or off-the-shelf software” which is standardised and marketed as such. When an off-the-shelf software is sold there appears to be little doubt that the essence of such transaction is an outright sale. But when a customised software is sold, a doubt on the nature of transaction can certainly arise. The former is clearly a sale of a copyrighted article, but the later may fall in the category of granting of licence to exploit a copyright.
Whereas Indian tax laws do not throw any light on the above controversy, the OECD Commentary clarifies the distinction between the right to use copyright and transfer of a copyrighted article. According to OECD, only a transfer that enables a transferee to commercially exploit software copyright will give rise to royalty income. But where the transferee gets exclusive rights for use, though short of full ownership, it will nevertheless be a case of sale of software. In such cases, the transaction will be outside the tax net in India.
In the above background, a recent decision of Karnataka High Court is very important. The court, in a decision delivered on September 24, 2009, held that technology firms are obliged to deduct tax at source on purchase of software from global vendors such as Microsoft. The High court accepted the Income tax Department’s argument that software purchase amounts to royalty payment in consideration for a licence to use it: it is not a mere purchase of goods.
It must, however, be noted that the Karnataka High Court Judgment is in relation to deduction of tax at source. The court did not venture into the question whether purchase of software amounted to royalty payment or not. The court merely said that the firms buying software should not sit on judgment whether the recipient is obliged to pay tax in India. They have to deduct tax the moment they make payments to a non-resident party.
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Despite the aforesaid fact, the judgement sends across a feeling that when foreign companies transfer computer software rights to any concern in India, they will be liable to be taxed in India.
It is therefore felt that the government. should clarify the law on taxability of transfer of software from foreign companies to Indian companies because a large number of technology firms, and all those using foreign software against payment will be directly affected by the interpretation given by Karnataka High Court. The CBDT should clarify the stand of the Government so that foreign companies are not unnecessarily dragged into litigation in India. (Author is a Sr. Partner in S.S. Kothari Mehta & Co.)