Off-the-Shelf Software Is Not a “Royalty” – Supreme Court’s Engineering Analysis Ruling Still Shapes Every Cross-Border Software Deal
Summary of the case
A four-judge dispute that ran for over a decade was finally settled by the Supreme Court in March 2021. At stake was whether payments made by Indian distributors and end-users to non-resident software suppliers, for the right to use shrink-wrapped, off-the-shelf or downloaded software, qualified as “royalty” under Section 9(1)(vi) of the Income-tax Act, 1961 read with Article 12 of the relevant DTAA. The Court held that they do not. What the buyer acquires is a copyrighted article, not the copyright itself, and so no withholding obligation under Section 195 arises. The 86-appeal batch judgement overruled the Karnataka High Court line of decisions and brought Indian jurisprudence back in alignment with the OECD Commentary on Article 12.
Why it is important for businesses
This is the single most consequential cross-border software ruling of the last decade, and its impact has not faded. Every Indian company that imports software, SaaS resellers, IT distributors, pharma giants licensing CAD tools, banks running foreign trading platforms, automotive OEMs buying simulation software — was facing 10% to 15% withholding plus interest plus penalty exposure on payments routed through intermediaries. After this ruling, those payments are “business income” of the foreign supplier, and unless the supplier has a Permanent Establishment in India, no Indian tax sticks. Practically, this freed up working capital, ended a flood of refund claims, removed the trigger for grossing-up clauses in IT procurement contracts, and forced finance teams to revisit the indemnity language they had quietly accepted in vendor agreements. CFOs of MNCs that had been paying tax under protest can now move on; CFOs of those who had not withheld can sleep easier on past assessments.
Facts of the case
The Supreme Court consolidated 86 appeals into four buckets. The lead category involved Engineering Analysis Centre of Excellence, an Indian end-user that imported software directly from a US supplier. Other categories covered Indian distributors who bought software from foreign suppliers and resold it to Indian end-users; Indian distributors of software bundled with hardware; and software supplied directly to Indian end-users by a foreign supplier through Indian distributors. In each case, the Revenue’s stand was that the payments were “royalty” because the right to use software involves a right to use copyright. The taxpayers argued that what they bought was a copyrighted article — a copy of the program, used within the limits of the End User Licence Agreement — not the underlying copyright. The matter had a chequered history: the Karnataka High Court (in Samsung Electronics and a chain of follow-on rulings) had consistently ruled in favour of the Revenue, while the Delhi High Court in DIT v. Infrasoft Ltd. and DIT v. Ericsson A.B. had ruled the other way. The Supreme Court was thus called upon to settle the conflict.
Analysis in the Judgement
Justice Nariman, writing for the bench, anchored the analysis in two observations. First, the definition of “royalty” in Article 12 of the DTAAs (which the Court treated as the operative definition by virtue of Section 90(2)) requires a payment for the use of, or right to use, a copyright. The Copyright Act, 1957 grants the copyright owner specific exclusive rights — to reproduce, to issue copies to the public, to make adaptations, etc. An EULA that allows the end-user only to install and run the software, with explicit prohibitions on reproduction, modification, or further distribution, does not transfer any of these copyright rights. What is sold is the copy itself — the copyrighted article — analogous to buying a book.
Second, the Court rejected the Revenue’s argument that the 2012 retrospective expansion of “royalty” in Explanation 4 to Section 9(1)(vi) (which expressly brought “computer software” within the royalty definition) could override the DTAA. Section 90(2) lets the taxpayer choose the more beneficial of the Act and the treaty, and the treaty definition was unaltered. The Court further observed that India’s reservations to the OECD Commentary on Article 12 do not, by themselves, alter the bilateral treaty text agreed by the contracting states.
My additional analysis
The ruling has a quiet ripple beyond software. The Court’s emphasis on the treaty-versus-Act hierarchy under Section 90(2), and its refusal to let a unilateral domestic amendment redefine a treaty term, has been cited in subsequent disputes on FTS, equipment royalty, and even cross-border data services. For Indian payers it is a useful reminder: where a DTAA exists and is more favourable, the treaty text — read with the Vienna Convention principles of treaty interpretation — must guide the withholding analysis, even if a Finance Act amendment appears to expand the domestic head of charge.
Conclusion
The Supreme Court held that payments by Indian residents to non-resident suppliers for the use of off-the-shelf, shrink-wrapped or downloadable software do not constitute royalty under the relevant DTAAs, and consequently no tax is deductible at source under Section 195. The Karnataka High Court line of decisions stood overruled. For businesses, the ruling is now black-letter law and should be embedded in every software procurement workflow.
What businesses should do?
- Audit live foreign software vendor contracts: confirm the EULA does not transfer any of the Copyright Act rights, and remove the assumption of 10% withholding from the payable build.
- Re-paper grossing-up and indemnity clauses that pre-date the ruling — most of them no longer reflect the legal position.
- Where TDS was deducted in earlier years on a “without prejudice” basis, evaluate refund claims within the limitation window.
- For any customised software, services bundled with software, or cloud-based managed services, do not extend this ruling reflexively, those still need a separate Section 9 / Article 12 / Article 7 analysis.
Source: Engineering Analysis Centre of Excellence Private Limited Vs CIT (Supreme Court of India)
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