Making sense of software laws

FOREIGN ENTERPRISES

The term software is defined in the commentary of the OECD Model Tax Convention as: "Software may be described as a programme, or series of programmes containing instructions for a computer required either for the operational processes of the computer itself (operational software) or for the accomplishment of other tasks (application software).

Software may be standardised or tailor made for single users. It can be transferred as an integral part of computer hardware or in an independent form available for use on a variety of hardware.

Whether the payments received as consideration for the transfer of computer software can be classified as 'royalty' or 'fees for technical services' is a complex issue. The OECD commentary states that the character of payments on transfer of software will depend upon the nature of rights that the transferee acquires.

The rights in a computer programme are in the form of intellectual property. Most of the countries recognise a distinction between (i ) the copyright in the programme and (ii) a software which incorporates a copy of the copyrighted programme. This can be illustrated by taking the example of purchase of a book or a music cassette.

In a transaction of purchase of book or cassettes, what is purchased is a copyrighted article, the copyright continues to belong to the author of the book or the singer of the song, as the case may be. The purchaser has no right to duplicate or make copies of the work that is purchased.

On the other hand, transfer of a computer program will be classified as a transfer of a copyright if, as a result of the transaction, a person acquires a right to make copies of the computer programme.

It appears that where the consideration is paid for the transfer of the ownership of the rights in the copyright, the payment cannot represent a royalty (see para 15 of OECD commentary on article 12 and also Lucent Tech Hindustan Ltd vs ITO 270 ITR 62 (AT)). Where the ownership of rights has been alienated in full or in part the consideration will fall in the category of 'business profits'.

Therefore, when a foreign company transfers a computer software in India in a manner that the purchaser acquires full or partial copyrights, the said transaction will be regarded as a transaction of "sale" rather than a transaction involving "royalty" or "fees for technical services".

Where a software is sold by a foreign enterprise along with the hardware, the sale of software will not attract any tax in India on another ground also, i.e., the software supplied by the non-resident company was customer specific and was inextricably linked to acquisition of hardware (see 270 ITR 62 (AT)).

The above situation will also hold good in a case where the transferee obtains rights to make multiple copies of the programme for operation only within his own business (para 14.2 of the OECD commentary).

The views expressed in the OECD commentary have also found favour in the report of the high-powered committee on electronics commerce and taxation constituted by the CBDT (251 ITR 118 (St)).

In the above context, reference may also be made to the ruling given by the Authority for Advance Rulings in a case reported in 255 ITR 354, wherein sale of engineering drawings and designs by a US company to an Indian company was held to be a transaction of 'sale', and therefore outside the ambit of 'royalty'.