Case Law Details

Case Name : AAR rules on taxability of software payments as per India-Netherlands tax treaty
Appeal Number : A.A.R. No. 774 of 2008
Date of Judgement/Order :
Related Assessment Year :
Courts : Advance Rulings

Court: Authority for Advance Rulings

Citation: A.A.R. No. 774 of 2008

Brief : In this Ruling Authority for Advance Rulings decided on tax ability of certain computer software payments. Having regard to the facts of the case, the AAR distinguished between transfer of ‘rights in copyrighted software’ and transfer of a ‘copyrighted software’ and observed that mere transfer of computer software de-hors any copyright associated with it, would not amount to royalty. Accordingly, the payments were held not to be in the nature of royalty nor fees for technical services (FTS) under the India-Netherlands tax treaty (Treaty). In view of the fact that the Applicant does not have a permanent establishment (PE) in India, it will not be taxable in India.

Facts and background- The Applicant, incorporated in the Netherlands, is engaged in the business of supplying special purpose computer software to be used in the exploration and production of mineral oils. The software is off-the-shelf, i.e., it is not prepared to suit any special requirements of the customer. The Applicant was awarded a contract to supply certain computer software to an Indian customer (Customer).

As per the agreement between the Applicant and the Customer (Agreement), an exclusive, non- transferable license is granted to the Customer. The transfer of title of the computer software takes place at the Applicant’s location (i.e., the Netherlands) and the consideration is also received outside India in USD.

Other essential clauses in the Agreement with respect to computer software usage are: (i) The Applicant/ licensor shall, at all times, retain the intellectual property rights contained therein. (ii) On termination of the Agreement, the Customer shall discontinue all uses of the software and return the same along with copies of the same. (iii) The terms of ‘use’ place a number of restrictions on the user i.e. the Customer and in this regard, its use is limited to processing of information and the process of copying, recording or transcribing the software. It specifically does not include modifying the software, creation of derivative version, reverse assembling or distributing it to other parties.

Under the Indian Tax Laws (ITL), the term ‘royalty’ is defined to include consideration for transfer of all or any rights (including the granting of a license) in respect of any copyright, literary, artistic or scientific work. The Treaty defines royalty to include consideration for the use or right to use any copyright of literary, artistic or scientific work.

Issue for consideration

Whether the income from supply of software would be taxable as royalty under the ITL or under the Treaty?


The Applicant stressed on the distinction between transfer of copyright in a product and the transfer of a copyrighted product. Since the transfer comes under the latter category, the payment relating thereto should not be taxable as royalty.

The Tax Authority however argued that the Agreement granted the right to use the software together with the copyright contained therein. Subsequently, at the final hearing, it was contended that the payments may be characterized as FTS, in view of the AAR ruling in the case of Airports Authority of India [1] (AAI), which held that software payments in certain cases may constitute FTS.

The AAR Ruling

  • · The crucial question of dispute is whether the payment made to the Applicant, confers any rights in respect of the copyright or a right to use the copyright attached to the software supplied and licensed by the Applicant.
  • · Reliance was placed on two earlier AAR rulings, viz., FactSet Research Systems Inc. [317 ITR 169] and Dassault Systems K.K. [322 ITR 125]. (Dassault), which dealt with this issue and adverted to the relevant copyright law. In particular, reference was made to the Dassault ruling wherein it was concluded that what was transferred to the end-user was copyrighted software, but not the copyright contained therein.
  • · Mere transfer of computer software de-hors any copyright associated with it, would not amount to royalty. As the facts in the Dassault case were substantially similar to that in the present case, the Dassault ruling was held to be applicable on principles.
  • · Terms in the Agreement such as granting a non-exclusive, non-transferable license to use the software, use limitations, retention of the IPRs with the Applicant/licensor ensures that the IPRs are not commercially exploited by the Customer. Consequently, it cannot be inferred that the rights in respect of the copyright or the right to use the copyright have been conveyed to the Customer. Transfer of such rights is also not evident in the Agreement.
  • · The AAR did not accept the Tax Authority’s contention that under the ITL, what is contemplated under royalty is mere ‘authorization’ to use computer software and not necessarily the transfer of the copyright contained therein. Under the ITL, what is contemplated is the transfer of all or any rights ‘in respect of any copyright’. Thus, the important criterion is whether any copyright has been transferred or not. However, the AAR preferred to analyze the Treaty provisions, instead of proceeding further under the provisions of the ITL.
  • · Under the Treaty, what is contemplated is the conferment of the right of usage of the copyright vested in the owner. Reliance was placed in the OECD Commentary in this regard.
  • · The AAR also distinguished its previous ruling in the case of AAI. The AAR observed that in the AAI ruling the contract would not fructify unless, in addition to the software licensed, technical knowledge, information and experience were imparted by the supplier. Thus, the dominant purpose was FTS. The AAR held that the facts of the present case differ materially and, therefore, the AAI ruling is not applicable.
  • · In light of the above, the payments were held not to be in the nature of royalty or FTS, under the Treaty. In view of the fact that the Applicant does not have a PE in India, it will not be taxable in India.


The characterization of computer software income arising from cross-border transactions has been a controversial issue with the Tax Authority over the last several years. The Tax Authority has generally adopted the view that such payments are ‘royalty’. The present ruling is consistent with earlier rulings on the tax ability of payments made for licensed computer software. The AAR acknowledges the position, based on certain precedents, that characterization of payments for computer software should be determined, having regard to the nature and extent of rights granted to the purchaser and the provisions of copyright law would be relevant for this purpose.

A ruling by the AAR is binding only on the Applicant, in respect of transaction in relation to which the ruling is sought and on the Tax Authority, in respect of the Applicant and the said transaction. However, it does have persuasive value and the Courts in India, the Tax Authority and the appellate authorities do recognize the principles and ratio laid down by the AAR, while deciding similar cases. Other taxpayers who would like to achieve certainty on the classification of their software transactions could consider approaching the AAR for a ruling, after evaluating the facts of their respective cases.

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  1. Gaurav agrawal says:

    In case of software services provided to netherland client from Indian software company what kind of tax will be applied on billing to the client and what percentage, like we apply services tax @10.3% for an Indian client ?

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