CA NeWs Beta*: SOFTWARE PURCHASE ROYALTY

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Monday, October 24, 2011

SOFTWARE PURCHASE ROYALTY

Software purchase and royalty
MOHAN R. LAVI
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MOHAN R. LAVI If software companies in Andhra Pradesh are finding the Telengana imbroglio to be tedious, software companies in Karnataka would henceforth find TDS provisions to be tedious after the Karnataka High Court (KHC) has stuck to its guns that payment for shrink-wrapped software amounts to payment of royalty which is taxable in India, thereby attracting withholding tax provisions.

The TDS battle was played out in all appellate forums with the Income-Tax Appellate Tribunal's order that no tax would need to be deducted on such payments commencing the litigation. The revenue did not find an ally in the KHC which held otherwise in the epoch-making Samsung case.

Guided Missile

In the course of its judgement, the KHC took the liberty of giving a rough and crude comparison to the way the disputed Section 195 of the Income-Tax Act operated.

It observed that the obligation on part of the resident payer who makes a payment to the non-resident recipient is like a guided missile which gets attached to the target the moment the resident assessee makes payment to the non-resident recipient.

There is no way of the resident payer avoiding the guided missile zeroing on the resident payer whether by way of contending that the amount does not necessarily result in the receipt of an amount taxable as income in the hands of the non-resident recipient under the Act or even by contending that the non-resident recipient could have possibly avoided any liability for payment of tax under the Act.

The opinion of the KHC was guided largely by the decision of the apex court in Transmission Corporation of India wherein it was held that all payments made to non-residents would attract withholding tax provisions irrespective of the taxability of the payment.

The defeated deductors approached the Supreme Court.

The SC did not disappoint the deductors. It distinguished the Transmission Corp case from the Samsung by stating that the former was a composite transaction with a taxable portion embedded in it.

SC decision

It was of the opinion that the KHC had not judged the case on its merits and returned it back to them with a instruction to judge the case de novo and answer two questions — whether on facts and circumstances of the case the ITAT was justified in holding that the amounts paid to the foreign software suppliers was not royalty and the same did not give rise to any income taxable in India and therefore the payer was not liable to deduct any tax at source.

KHC Decision

The KHC in a recent ruling answered both the questions in the negative. It ruled that payment for royalty for shrink-wrapped software would tantamount to an income taxable in India which is taxable under Section 9 of the Income-Tax Act 1961.

Once the above conclusion was agreed, the tax deduction provisions would follow unfailingly.

Many of the appeals on which the decisions of the ITAT were made pertained to years 2005 and 2006.

The original decision of the KHC was in September 2009 and the Supreme Court a year later. As the deductors found a shoulder to lean on in the form of the Supreme Court the first time, this dispute is bound to be escalated to it again. Going by historical precedents, the SC decision can be expected in about a year's time if the dispute is referred to it by which time the Direct Taxes Code will be in place.

Section 195 of the DTC narrates deduction of tax at source on specified payments which are detailed in Schedule III and IV for residents and non-residents respectively.

Payments for royalty and fees for technical services would see hair-cuts of 20 per cent for taxes deducted.

While the question whether tax has to be deducted on payments as royalty and technical fees is a no-brainer, whether payments for purchases of software in the normal course of business can be deemed to be royalty is something the apex court would have to brainstorm about.

Textbooks define royalty to be usage-based payments made by the licensee to the licensor for the right to ongoing use of an asset.

There seems to be a bug in applying this definition to software purchases due to the use of the word usage-based payment.

An entity can purchase a software application, pay for it and trash it without even installing it due to its unsuitability. It appears that only the Supreme Court can debug this.

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Whether payments for purchases of software in the course of business can be deemed royalty is something the apex court will have to decide now.

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(This article was published in the Business Line print edition dated October 24, 2011)

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